R—403(b) Plans

403(b) plans are available to employees of public schools and colleges, and certain nonprofit hospitals, charitable, religious, scientific, and educational organizations. A 403(b) plan is also referred to as a “tax sheltered annuity,” or “TSA.” Rather than “tax sheltered annuity,” the Securities and Exchange Commission prefers the term “tax deferred annuity.” Many companies now use the terms “tax deferred annuity” and “TDA,” particularly when marketing variable annuities. 403(b) plans are also referred to as: (1) “qualified” annuity plans; and (2) “501(c)(3) plans” or “501(c)(3) pensions” (Section 501(c)(3)
describes certain tax-exempt organizations).

The employee may supply the funds by agreeing to a salary reduction, or by foregoing a salary increase, or the employer may make contributions as additional compensation to the employee. Contributions are before taxes, meaning that a participant is able to exclude the contributions from his current taxable income. Where a reduction in salary is taken to provide the premium payments for a 403(b) plan, Social Security taxes and benefits are based upon the unreduced salary (i.e., although income taxes are reduced, there is no reduction in Social Security taxes).

Generally, with a salary reduction plan the lowest of these two limits may be excluded from income each year:

• A limit of $23,000 in 2024, which also includes total salary reduction contributions


• to 401(k) plans, simplified employee pension plans and SIMPLE IRAs. “Catch up” provisions allow: (1) certain employees with 15 years of service to increase this amount by an additional $3,500; and (2) employees who have attained age 50 to increase this amount by an additional $7,500 in 2024.


• The lesser of $68,000 (in 2024) or 100 percent of compensation, made to all defined contribution plans by the same employer.

The compounding effect of before tax contributions and tax-deferred growth may result in substantially increased accumulations. Because the annuity is generally portable to another qualified employer, contributions may be continued when changing employment.

Distributions from tax deferred annuities are subject to ordinary income taxes, unless rolled over into a traditional Individual Retirement Arrangement (IRA), another 403(b) plan, a 401(k) plan, a 457 government plan, or a 401(a) qualified retirement plan. However, if the employee has an investment in the contract, he or she is allowed a tax-free recovery of his or her investment. Examples of an employee’s investment in the contract include: (1) any premiums that the employee has paid with nondeductible dollars; (2) any employer contributions that were taxable to the employee by virtue of having exceeded his or her exclusion allowance in years before 2002 or the overall limit; (3) the sum of the annual one-year term costs that were taxable to the employee (where the contract provided life insurance protection); and (4) the amount of any loans included in income as a taxable distribution. When benefits are received in installments, or as a life income, the employee’s investment in the contract requires the calculation of an exclusion ratio. The method used to determine the exclusion ratio depends upon the annuity starting date. Distributions are generally subject to mandatory withholding of 20 percent unless the employee elects a direct rollover.

In addition, withdrawals may be subject to a 10-percent penalty tax. However, penalty-free withdrawals are allowed once the participant has attained age 59½, separated from service after attaining age 55, or under other specific circumstances. These additional specific circumstances include: (1) death; (2) disability; (3) as a part of substantially equal periodic payments beginning after separation from service; (4) when used for medical expenses exceeding 7.5 percent of adjusted gross income; (5) distribution of excess contributions within the same calendar year; (6) payments to an alternate payee under a qualified domestic relations order; and (7) penalty-free withdrawals for military reservists.

With some restrictions, tax-free loans are also available. The maximum tax-free loan is generally one-half the contract value, or $50,000, whichever is less. However, an exception is available for the first $10,000 of cash value, all of which may be borrowed. Loan repayments must be made at least quarterly and in amounts that allow for amortization over five years, except for loans to purchase a primary residence, which may be repaid over a longer “reasonable” period.

Required distributions of amounts accruing after 1986 generally must begin by April 1st of the year following the year in which the employee retires or attains age 70½ (72 after 2020), whichever is later. Payments made under an annuity contract may be for the life of the employee (or lives of the employee and his beneficiary), or a period certain not longer than the life expectancy of the employee (or joint and last survivor life expectancy of the employee and his
beneficiary).