Not-for-profit groups, such as public schools or hospitals, can offer their employees the ability to save in a 403b plan, which functions similarly to 401k plans offered by corporations. If you understand the tax benefits of a 401b plan, you can make a more informed choice as to whether it is right for your retirement savings needs.
Money Contributed to Your 403b
Money that you contribute to your 403b plan during the year does not count as taxable income. This also includes money that your employer elects to contribute on your behalf. This can save you a significant amount on your income taxes. For example, if between you and your employer $10,000 is contributed to your 403b plan and you fall in the 33 percent income tax bracket, you would save yourself $3,300 on your income taxes.
Earnings in the 403b Plan
When you invest the money in the 403b plan, your contributions will likely generate returns on your investment. These earnings avoid income taxes as long as the money stays in the account. In addition to this keeping more money in your account, it also helps the account balance increase at a faster rate because the money that you would have paid in income taxes continues to generate income in future years.
Withdrawals From the Account
All withdrawals from a 403b plan are taxable. The IRS does not set a specific income tax rate for money taken out of a 403b plan. Instead, the amount of the withdrawal is simply reported as part of your taxable income for the year and taxed as any other income. For example, if you fall in the 25 percent tax bracket during the year you take out money from your 403b plan, the withdrawal is taxed at 25 percent.
Because the money from your 403b plan is only taxed when you take a withdrawal from the account, the best benefits are for people who expect to fall in a higher income tax bracket during the years the contribution is made than at the time the money is taken out of the 403b plan. If you expect the opposite to be true, consider investing in a Roth 403b plan if your employer allows you that option.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."