Types of 403(b) plans
Eligibility for contributing to a 403(b) plan
Advantages of a 403(b) plan
Making contributions to a 403(b) plan
Catch-up provisions
Investing 403(b) contributions
Borrowing from a 403(b) plan
If you change employers
Withdrawing money from a 403(b) plan
Information from the Internal Revenue Service on 403(b) plans
403bCompare.com

A 403(b) plan is a retirement plan that is available to employees of educational institutions, churches and many other tax-exempt organizations. These plans are sometimes known as tax-sheltered annuities (or TSA) or tax-deferred annuities (or TDA). Not all 403(b) plans are annuities, however. There are plans known as 403(b)(7) plans that allow employees to invest in mutual funds, similar to a 401(k) plan. The Voluntary Investment Program, administered by CalSTRS, is a 403(b)(7) plan.

Unlike the Defined Benefit Program, Defined Benefit Supplement Program and the Cash Balance Benefit Program, which is also administered by CalSTRS, with VIP you are allowed to pick your investments and your deferral amounts for building up your retirement account through your salary deferrals and investment choices.

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Any employee of specific employers, such as public schools, colleges, universities, hospitals and churches, may participate in a 403(b) retirement plan. VIP is available to any employee of a local employer whose employees perform service covered by CalSTRS. As a result, any California school district, office of education or community college district employee, whether certificated or classified, may participate in VIP.

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There are three advantages to investing in a 403(b) plan:

1. It can make your retirement more comfortable. Although benefits provided by CalSTRS can be substantial, particularly for career educators, they may not be sufficient to maintain your standard of living in retirement. For example, CalSTRS members do not earn Social Security benefits on their covered-service to supplement their retirement benefits. Saving in a 403(b) plan can help augment your CalSTRS benefits.
2. Saving in a 403(b) plan is a disciplined way to build a retirement nest egg.
3. Both federal and state law provide significant tax advantages to you if you save in a 403(b) plan.

There are three tax advantages to a 403(b) plan:

1. Contributions into the plan reduce your taxable income for the year it's contributed. As long as you don't exceed the pretax limit, your contributions are deducted from your pay before California and federal income taxes are withheld. You don't pay income taxes on this money until you withdraw it from your account.
2. The earnings credited to your account grow tax-deferred. This is a powerful tool you can use to help build your retirement nest egg. For example, if you save $1,000 in your 403(b) plan and earn $80 in interest, the entire $80 is reinvested in your account, helping your investments grow faster, because contributions and earnings in 403(b) plans grow tax-deferred. You will be required to pay taxes when you withdraw your contributions and earnings when you retire. Your income in retirement may be lower than while you are working, however, so your tax burden may be less.

   If, however, you invested $1,000 in an after-tax investment account that earns an 8 percent annual interest, that money earns $80 a year. If your annual income is $50,000, putting you in the 28 percent tax bracket, you will have to pay taxes on your interest ($22), reducing your real return to $58.

3. You may be eligible to take a federal tax credit for amounts contributed to your 403(b) account beginning in 2002. The credit is up to 50 percent of the amount contributed (up to $2,000 in contributions), including contributions to a traditional IRA, Roth IRA, 457 plan or 401(k) plan,. The percentage of contributions that you can take as a credit depends on your adjusted gross income.

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You make contributions to a 403(b) plan by completing a salary reduction agreement with your employer. Your employer defers paying you the amount you indicate in the agreement from your paycheck. The maximum amount you can contribute (or "defer") annually to a 403(b) plan is set by federal law. For most participants, the maximum allowable contribution in 2007 is $15,500.

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You may be able to contribute an additional amount if you have worked for the same employer for the equivalent of 15 full years, and in the past you have contributed an average of less than $5,000 per year to a 403(b) plan. (Only employees with at least 15 years of service with the employer qualify. Each full year of full-time employment is one year of service; partial years of full-time employment and time spent in part-time employment are pro-rated to determine total years of service.) You can contribute up to an additional $3,000 per year under this provision. The total amount that you can contribute under this provision cannot be more than $15,000.

Example: Mary is 59 years old and has worked for XYZ Unified School District for 15 years. For the first 13 years she contributed $4,000 each year into a 403(b) plan. In 2005 she contributed $7,000 and in 2006 she contributed $8,000. (Her total contributions through the end of 2006, then, were $67,000.) Since she is planning to retire at the end of 2007, her 16th year, she wants to use the catch-up limit to maximize her 2007 contributions. In addition to the regular $15,500 dollar limit, she can contribute an additional $3,000 under the catch-up provision, for a total of $18,500. Her average annual contribution is then $5,343 ($80,000 divided by 16 years), so she cannot contribute any more in 2008.

Finally, for some participants, there is a second catch-up provision, even if you have reached the legal limit for making contributions during the year. That provision permits a person who is age 50 or older at some time during the year to contribute an additional $5,000 in 2007.

You may make these two types of catch-up contributions only if the 403(b) plan sponsor permits such contributions. VIP permits you to make such contributions.

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In general, two types of investments are allowed in 403(b) plans:

1. An annuity contract can be either an individual or a group contract that provides fixed retirement benefits to the plan participant for life, and possibly for a surviving spouse. Variable annuities may also be offered.
2. A mutual fund custodial account is an alternative to an annuity contract, but works much the same way. Typically, you can invest your money in mutual funds made available by the plan. VIP is administered in this fashion.

Different types of 403(b) plans that invest in annuity contracts or are custodial accounts will impose a variety of charges, including

• Administration fees for keeping track of the accounts and providing other services
• Custodial fees for safekeeping or physically holding the securities in the fund
• Expense deductions for investment management, administration and distribution services
• Loads are imposed either at the time of investment or redemption by some funds to pay commissions to brokers, planners or advisers
• Management fees, or investment advisory fees, which pay the investment company's cost for managing the money in the fund
• Mortality and expense (M&E) charges apply to some types of annuities and cover insurance related costs
• Transfer fees to transfer either within the fund family or to another company
• Wrap account fees by some types of funds for fund management; this is an annual percentage of the investor's assets in the account
• Withdrawal, or surrender, charges when an investor takes money out of his or her account

VIP only charges a recordkeeping fee to cover the costs of managing the program and providing advice services to VIP participants. VIP investment options also charge an investment management fee, which varies by individual fund option. None of the funds in VIP charge a load to VIP participants, although they may impose a load if purchased outside of VIP. Additional fees are imposed for participants who invest in the VIP Self-Managed Account or borrow from their VIP account.

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Different 403(b) plans have different rules for borrowing from a 403(b) account. VIP permits you to borrow a total of up to 50 percent of your account balance (up to $50,000). The amount you can borrow will be reduced by the amount of any prior outstanding balance. If you participate in more than one 403(b) plan, they are considered to be a single program when determining these limits. The amount of interest you pay on the loan will vary by plan. With VIP, the interest rate is the prime rate plus 1 percent.

Repayments of loan principal and interest are usually deducted directly from your paycheck after taxes and deposited in your 403(b) account. You generally have to pay the loan back within five years unless it is used for the purchase of a primary residence, in which case you may take longer. In VIP, you have up to 15 years to repay funds borrowed for a primary residence.

While it may seem like a good idea to borrow from your 403(b) plan, there are actually some big disadvantages in doing so:

1. The money you withdraw is no longer earning compound interest or investment earnings. As a result, your overall account will be much smaller when you retire -- especially if you also stop your deferrals while you are paying back your loan.
2. You will be taxed twice on the interest you pay on the loan and on the money you use to replace the loan amount: once when you get your paycheck and again when you eventually withdraw money from your 403(b) account after retirement.
3. If you terminate your employment, you will probably have to pay back the full amount of the loan immediately. If you don't, you have defaulted on the loan, and the loan will be treated as an early distribution from your plan. As a result, you will be subject to federal, state and local taxes on the entire amount, plus most likely a 10 percent federal early withdrawal penalty and a 2½ percent California early withdrawal penalty if you are under 55 when you leave your employer.
4. If you fail to repay the loan, it will be considered a taxable distribution and subject to the early withdrawal penalties, plus any applicable federal, state and local taxes.

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If you continue to work in the California public schools, you can continue to contribute to a 403(b) plan, including VIP if offered by your new employer. You may roll over your 403(b) money into a new employer's 403(b), 401(k), or governmental 457 plan if the new employer's plan accepts rollovers. You may also roll it over into an IRA. Doing a rollover is generally a good idea because it lets you maintain the account's tax-deferred status and avoid paying taxes on the money until you withdraw it, ideally in retirement.

If your new employer doesn't allow rollovers, you have two other options that would allow you to maintain the account's tax-deferred status.

1. If your account balance is $5,000 or more and you're under age 65, you can leave your money in your previous 403(b) plan -- and taxes won't be due until you withdraw money. Alternatively, you can roll over your 403(b) into a traditional IRA. If you do a direct rollover -- have the money transferred directly into the new IRA -- you won't owe taxes until you withdraw money from the IRA.
2. If your balance is less than $5,000, different plans have different rules. VIP requires that you either take the funds in a lump sum distribution or roll it over to another qualified plan, a 403(b) plan, a 457 plan, or an IRA. If you take a lump sum distribution, you will have to pay income tax and, depending your age, penalties. If you roll the funds to another plan, you will not have to pay taxes at that time.

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Once you reach age 59½, you can generally begin to withdraw money from your 403(b) with no penalty. Federal, state and local income taxes are due on the amount you withdraw.

Distributions before age 59½ may be allowed under the following circumstances:

• If you die.
• If you are totally disabled.
• If you qualify for a "financial hardship" distribution. You may qualify for a financial hardship withdrawal if you need the money: (A) to pay college tuition and related educational expenses for yourself or a dependent, provided they're due within the next 12 months; (B) to make a down payment on a primary residence; (C) to pay medical expenses for you or your dependents; or, (D) to prevent foreclosure or eviction from your home. As a VIP participant, you would have to prove that you have exhausted all withdrawal possibilities, such as borrowing the maximum allowable amount from your VIP account. In addition, you will not be permitted to make contributions to VIP for six months.

While distributions are generally allowed for these reasons, you could still be liable for a 10 percent penalty from the IRS and a 2½ percent California penalty for early withdrawal. Any penalties imposed for early withdrawal will be based on the entire untaxed amount that you withdraw. For a $5,000 early withdrawal, for example, you would owe a penalty of $500 to the federal government and $125 to California, if a California taxpayer, plus applicable federal, state and local taxes on the entire $5,000. All applicable federal, state and local income taxes are also due on the amount you withdraw.

You will not have to pay the 10 percent and 2½ percent early withdrawal penalty if the distribution occurs for one of the following reasons:

• Your death.
• Your disability.
• Unreimbursed medical expenses exceeding 7.5 percent of your adjusted gross income.
• If you are required by court order (called a qualified domestic relations order) to give the money to your divorced spouse, a child or dependent.
• If you are separated from service (through permanent layoff, termination, quitting or taking early retirement) and you were at least 55 years old when you terminate.
• If you are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution, you are required to continue the payments for five years or until you reach age 59½, whichever is longer.)

Any money withdrawn for the above reasons would still be subject to applicable federal, state and local income taxes.

Mandatory distributions from a 403(b) plan. For all money in the plan as of Dec. 31, 1986, you may wait until age 75 before you are required to take distributions from a 403(b) account.

For money contributed and earned in or after 1987, you must begin taking what are known as required minimum distributions no later than April 1 of the calendar year following the calendar year in which you reach 70½. If you are still working at age 70½ for an employer who may offer a 403(b) plan, you must begin taking the distribution by April 1 of the calendar year following the year in which you stop working for that employer.

If you fail to take required minimum distributions on time, or if you don't take out enough, you will be liable for a penalty of 50 percent of what you should have taken out.

The distribution for the first year (generally the year in which you turn 70½) must be made no later than April 1 of the following year. A second distribution must be taken by December 31 of that year, and subsequent distributions must be taken by December 31 of every year.

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The Internal Revenue Service publication on 403(b) plans is available at http://www.irs.gov/pub/irs-pdf/p571.pdf

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The 403bCompare Web site is a retirement planning tool that offers comprehensive, objective information about 403(b) vendors and the products they offer in California. Employees of the state’s local school districts, community college districts and county offices of education can use the site to learn more about the investment products offered through their employers and make better-informed investment decisions for their future.

California Education Code 25100 et seq requires the California State Teachers’ Retirement System to develop, maintain and administer this registry of vendors and their products. Effective July 1, 2004, all vendors who wish to offer tax-deferred 403(b) investment products in California must register with the site.

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