Retirement Plans - 403(b)

A 403(b) plan is a retirement savings plan that is funded by employee contributions and (often) matching contributions from the employer. Tax-exempt organizations (i.e., 501(c)(3) employers) such as churches, schools, and charities offer these plans to their employees.

In 2005, an employee can contribute up to $14,000 to the plan via payroll deductions. An employee age 50 or older is allowed an additional contribution of up to $4,000 as a "catch-up" provision. These employee contributions are taken from pre-tax income, so you don't pay income tax on that amount. The employer may make additional contributions, up to $28,000 in 2005, for a total contribution limit of $42,000. All contributions, even any contributions from the employer, become the property of the employee immediately. The plan defers taxes on the income and growth of that income until the monies are withdrawn. At withdrawal time the monies are treated as ordinary income.

The 403(b) plans are not "qualified plans" under the tax code, but are generally higher cost "Tax-Sheltered Annuity Arrangements". They can only be offered by tax-exempt organizations. They can only invest in annuities or mutual funds. So they are similar to qualified plans such as 401(k) plans, but have some important differences, as follows.

The rules for top-heavy plans do not apply.

Employer contributions are exludable from income only to the extent of employees "exclusion allowance." Exclusion allowance is the total excludable employer contribution for any prior year minus 20% of annual includible compensation multiplied by years of service (prorated for part-timers). Whew! I have no idea what this means. In my own case there is no extra employer contribution, but rather a salary reduction agreement. So the so-called employer contribution is actually my own contribution. At least I think it is.

Contributions to a custodial account invested in mutual funds are subject to a special 6% excise tax on the amount by which they exceed the maximum amount excludable from income. (This sounds scary as the calculation for excludable income seems quite complex. E.g., I already have another tax-deferred retirement plan which probably needs to be calculated into the total allowed in the 403b).

The usual 10% penalty on early withdrawal and the 15% excise tax on excess distributions still apply as in 401(k) plans.

As of 2002, an individual may participate in a 403(b) plan and a 457(b) plan at the same time. This is interesting for people who work at an employer that offers both plans.

NOTE: The above is my paraphrasing of the U.S. Master Tax Guide for 1993. Recent changes in the laws governing 401(k)-type arrangements have made these available to non-profit institutions as well, and this has made the old 403(b) plans less attractive to many.

This page from the IRS summarizes these plans:

http://www.irs.gov/retirement/article/0,,id=108946,00.html

      Retirement Plans - 457(b)

A 457(b) plan is a non-qualified, tax-deferred compensation plan offered by many tax-exempt institutions to their employees, especially by governments. This plan, like a 401(k) or 403(b) plan, allows you to save for retirement.

Contributions are made from pre-tax wages, and the Internal Revenue Code sets the maximum contribution limits. The limit for 2007 is the lesser of $15,500 or 100% of an employee's salary. Catch-up provisions apply to those 50 or older; these people can contribute an extra $5,000 in 2007.

Because contributions are made before tax, naturally this means that taxes are due when withdrawals are made. However, unlike qualified plans such as 403(b) plans, the 457(b) plans do not impose a penalty on early withdrawals.

Unlike other retirement plans, the assets in a 457(b) plan do not belong to the individual but are essentially represent a promise from the employer to you, the account holder. This is almost certainly fine for employees of large state universities, but could become an issue at a small non-government employer.

Funds from a 457(b) plan can be rolled into another 457(b) plan if you change employers. A public plan (i.e., government 457(b) account) can be rolled into a qualified retirement-savings plan such as an IRA or a 401(k). However, employes with private 457(b) plans are not allowed to roll funds from their 457(b) plans to a qualified plan such as an IRA.

The Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA) changed the rules, so as of 2002 an individual may contribute to a 457(b) plan and another plan, such as a 401(k) or a 403(b) plan, at the same time, and put the maximum amount allowed into both plans. Usually employers match contributions in a 403(b) but do not match contributions in a 457(b). So the common advice for people in this situation is that you should first fund the matched plan fully (e.g., a qualified 403(b)), and if your budget permits, then make contributions to a 457(b) plan.

TIAA-CREF offers a list of frequently asked questions and answers about these plans:

http://www.457bwise.com/faqs/index.html

       Retirement Plans - SEP IRA

A simplified employee pension (SEP) IRA is a written plan that allows an employer to make contributions toward his or her own (if self-employed) or employees' retirement, without becoming involved in complex retirement plans such as Keoghs. The SEP functions essentially as a low-cost pension plan for small businesses.

For 2007, employers can contribute a maximum of 25% of an employee's eligible compensation, or $45,000, whichever is less. In future years the maximum contribution will be adjusted for cost-of-living adjustments as published by the IRS. Be careful not to exceed the limits; a non-deductible penalty tax of 6% of the excess amount contributed will be incurred for each year in which an excess contribution remains in a SEP-IRA.

For the self-employed in an unincorporated business, the contribution
is 25% of the net profit from the business (not the gross income), less one-half of self-employment tax. The SEP calculation for unincorporated business is not at all straightforward because the sole proprietor has wages and is making a SEP contribution; the contribution is limited to 25% of wages after the SEP contribution is deducted. Because of the deduction, the official 25% contribution is effectively reduced to 20%. For example, a sole proprietor with self-employment income of $150,000 could contribute a maximum of $30,000 to his SEP for 2007.

An incorporated business, on the other hand, can contribute up to the full 25% of net profit, or $37,500 for an employee with W-2 income of $150,000 in 2007.

Employees are able to exclude from current income the entire SEP contribution. The SEP is an employer-contribution-only plan, meaning that even if the business is a one person shop, it is the business that is making the contribution to the plan. However, the money contributed to a SEP-IRA belongs to the employee immediately and always. If the employee leaves the company, all retirement contributions go with the employee (this is known as portability).

The IRS regulations state that employers must include all eligible employees who earned at least $500, are 21 or older, and have been with a company for 3 years out of the immediately preceding 5 years. However, employers have the option to establish less-restrictive participation requirements, if desired.

An employer is not required to make contributions in any year or to maintain a certain level of contributions to a SEP-IRA plan. Thus, small employers have the flexibility to change their annual contributions based on the performance of the business.

There is no age limit on employees who receive contributions from the employer. However, an employee who has a SEP account must begin taking distributions around age 70 1/2.

One of the pluses of the SEP is that a SEP can be opened and contributions made until the company's tax-filing deadline. For calendar-year corporations with a March 15 tax filing deadline, SEP-IRA contributions must be made by the employer by the due date of the company's income tax return, including extensions. So the contributions are deductible for the tax year as if the contributions had actually been contributed within the tax year. For example, contributions before March 15 are deductible for the prior tax year.

Sole proprietors have until April 15, or to their extension deadline, to make their SEP-IRA contribution if they want a tax deduction for the prior tax year.

On the minus side, the SEP does not allow participants to borrow from their account, nor does it allow participants over age 50 to put away an extra $5,000 in catch-up contribution, or to grow those funds tax-free in a Roth. For those features one should consider a Self-employed 401(k).

The SEP-IRA enrollment process is an easy one. It's generally a two page application process. The employer completes Form 5305-SEP. The employee completes the IRA investment application usually supplied by a mutual fund company or some other financial institution which will hold the funds. Nothing has to be filed with the IRS to establish the SEP-IRA or subsequently, unlike many other retirement plans that require IRS annual returns.

Contributions to SEP plans may be affected by contributions to other defined-contribution plans, as regulated by the "415 limit." The 415 limit is the total maximum contribution allowed for defined contribution plans (not including catch-up for those over 50). In 2007, the 415 limit is the lesser of 100% of taxable compensation or $45,000. This limit may be especially relevant to an individual who has a business *and* a W2 from an employer. Within the 415 limit there is also a limit of $15,500 for salary deferral to a 401K. And if the employer makes an employer contribution to a SEP or 401K for a participant, then that participant must make sure that all these contributions do not exceed the 415 limit for the year. Refer to IRS publication 560.

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