Internal Revenue Service Code 403b describes a tax-sheltered annuity. Available to cooperative and nonprofit hospital service employees, public education and self-employed ministers, these employee contribution plans rely on both tax- and income-deferred funds. The IRS has strict rules and regulations regarding 403b plans.
Investing Part of Your Income
If you can participate in a 403b plan through an agreement with your employer, you will defer a portion of your income into a retirement account via payroll deduction on a pre-tax basis. After making this designation, you can choose among several vendors offered by your employer to actually invest the 403b funds. According to the "403b Answer Book," common investment options offered by 403b plans include annuities and mutual funds. The IRS allows both your employee contributions and earnings to grow on a tax-deferred basis until you withdraw your money from the 403b plan or retire.
Selection Process and Contributions Limits
Not every employee can automatically elect to start participating in a 403b plan. Many employers require you to have a minimum number of service or to meet a specific minimum age before you can participate in a 403b plan. Once you meet the eligibility requirements, you have to complete an enrollment form and designate a percentage of each paycheck you want to put into the plan. For 2010, the maximum employee contribution allowed by the IRS is $16,500 for individuals under 50 and $22,000 for individuals 50 years and older. The IRS also allows you to contribute up to your entire earned income as long as you do not exceed these limits.
Employer Contribution Options
An employer can also choose to contribute to an employee's 403b plan. Employers can contribute to employee 403b plans by matching employee contributions up to 6 percent of the employee's income or through non-elective contributions. A nonelective contribution is a specific contribution made by the employer to every eligible employee account. An employee will receive these nonelective contributions even if the employee currently does not contribute to a 403b plan. For the 2010 tax year, total employer and employee contributions to a 403b account can not exceed $49,000 annually.
Income Deferral and Distribution Age
403b plans allow you to defer income by making contributions that reduce your overall income. According to the "403b Answer Book," avoid withdrawing funds from a 403b account. So long as the funds remain in the 403b account, you will defer your tax liability until the money comes out of the 403b account; 59 1/2 is the normal distribution age for 403B plans. Any distributions taken before this age will generally require you to pay a 10 percent penalty in addition to all taxes due on the withdrawn funds.
