403(b) Plan: Contributions

Employee Contributions 

If you want to contribute to a 403(b) plan, you have to do so through your employer. The most common way to contribute is by asking your employer to withhold money from each paycheck and deposit it directly in a 403(b) account in your name. This type of contribution is called an elective deferral made under a salary reduction agreement. (Related: How does a defined benefit pension plan differ from a defined contribution plan?)

You aren’t actually getting a lower salary under this agreement; you’re just putting some of your salary in a retirement account, which means your take-home pay will be lower now but you’ll be providing for your future retirement income. You might choose, for example, to have 5% of your salary deducted from each paycheck and deposited into your 403(b) plan. You probably won’t notice the difference today as much as you’ll appreciate having that money in retirement.

You don’t pay taxes on elective deferrals when you contribute to your account. You do pay taxes when you take distributions. Ideally, you won’t take any distributions until retirement. If you take money out sooner, you may have to pay a tax penalty. 

Employer Contributions 

Besides elective deferrals, another way to contribute to a 403(b) is through a nonelective contribution, which occurs when your employer puts money in a 403(b) account on your behalf. These types of contributions are like free money to you.

Sometimes, you have to contribute a certain amount to your 403(b) to receive a nonelective contribution; this is called a matching contribution. For example, if your employer provides a 50% match up to 5% of your salary and your salary is $50,000, by contributing 5% of your salary annually ($2,500), your employer will give you another 50% ($1,250). If your employer provides a 100% match up to 5% of your salary, your employer will give you an extra $2,500 when you contribute $2,500.

Other times, employers contribute a certain amount to your 403(b) regardless of how much you contribute; these nonelective contributions can come in the form of discretionary contributions, which are end-of-plan-year contributions or profit-sharing contributions, or mandatory contributions, where the employer contributes a certain percentage of the employee’s pay to his or her 403(b) account regardless of how much the employee contributes. Employees of some companies receive more than one type of employer contribution; it depends on the company’s policy. Just like your own contributions, you don’t pay tax on your employer’s contributions until you withdraw them. 

Some 403(b) plans allow participants to make after-tax contributions of up to 25% of their after-tax salary. The benefit of making such contributions is that they grow tax deferred. Like pre-tax contributions, withdrawals are taxable. 

Roth contributions might seem like the same thing as after-tax contributions, but the IRS categorizes them differently and requires employers to track them separately. The big difference between Roth contributions and after-tax contributions even though the employee uses after-tax dollars to make both types of contributions is that Roth contributions aren’t taxable when they’re withdrawn. Roth contributions also grow tax deferred. 

Salary Deferral and Employer Contribution Limits

The most you can contribute to your 403(b) each year is called the maximum amount contributable (MAC). 403(b) plans have two types of contribution limits: limits on annual additions and limits on elective deferrals. Annual additions are the sum of all contributions to a 403(b) plan except for rollover contributions and catch-up contributions; elective deferrals are the amounts withheld from your salary and contributed to your plan. In other words, elective deferrals are included in annual additions, as are employer contributions.

For 2017, you can make up to $18,000 in salary deferral contributions; for 2018, the limit is $18,500. If your employer contributes to your account as well, they can contribute up to $35,500 more, for a total of $54,000 in 2017, or $36,500 more, for a total of $55,000 in 2018. But if you make less than the annual addition threshold, the contribution limit is 100% of your compensation. 

In other words, you can’t earn $44,000 for the year and have a total contribution of $50,000 to your 403(b); your limit would be $44,000. And most people won’t be able to contribute 100% of their compensation because they need money for living expenses. An exception might be a married couple where the other spouse’s income is high enough and the couple’s expenses are low enough that one spouse can save 100% of their income.

If you contribute more than the IRS allows to your 403(b) plan, you may have to pay tax penalties. You may be able to correct an excess deferral and avoid penalties. 

Vesting

403(b) plans may have vesting schedules that determine what percentage of employer contributions fully belong to an employee after a certain number of years spent working for that employer. You might become 25% vested each year, which is called graded vesting, or you might become fully vested after a certain number of years, which is called cliff vesting. You also might be 100% vested right away.  (See also: How do I "vest" something?"

Suppose your employer contributes $2,000 to your 403(b) in your first year of working for them and uses a 25% graded vesting schedule. If you leave the company after one year, you’ll get $500 of that $2,000. After two years, you’ll get $1,000; after three, $1,500; and after four, the full $2,000.

Catch-Up Contributions 

Participants who are 50 or older can make catch-up contributions if the employer’s plan allows it Check the summary plan description to find out.

You can only make catch-up contributions if you’ve already maxed out your elective deferrals for that year. If you have, you can make up to $6,000 in annual catch-up contributions in 2017 and 2018, but you can’t contribute more than your annual earnings. Employers can also make catch-up contributions on your behalf, subject to the overall $6,000 annual limit. In other words, you can make $3,000 in catch-up contributions and your employer can make another $3,000 on your behalf, but you can’t each contribute $6,000.

Another type of catch-up contribution is called the 15-year rule because it applies to employees who have been with the same nonprofit for at least 15 years and who have contributed less than $5,000 per year, on average, in previous years. These employees can add another $3,000 in catch-up contributions for up to five years if the employer’s plan allows it. 

Rollover Contributions

The IRS allows rollovers to 403(b)s from most other types of retirement accounts. A rollover is a transfer of funds from one retirement account to another that follows precise rules to avoid tax penalties. You can do a rollover from a traditional IRA, SIMPLE IRA (after two years), SEP IRA, 457(b), pre-tax qualified plan such as a 401(k), or another pre-tax 403(b). You cannot do a rollover from a Roth IRA or designated Roth 401(k), 403(b), or 457(b).

In the next section, we’ll talk about 403(b) distributions.