(LifeWire) - A 403(b) plan is a retirement savings tool that's available to millions of employees of nonprofit corporations, schools and churches.
Similar to 401(k) plans, which are available to employees of private-sector companies, 403(b) plans allow workers to contribute a portion of their wages - up to $15,500 in 2008, or $20,500 for those 50 and over - to a personal retirement account. Contributions are free of income taxes in the year in which they are made, and investments grow tax-deferred until money is withdrawn.
Withdrawals taken before age 59 1/2 generally face a 10% penalty plus tax, with a few exceptions.
What Can You Invest the Money in?
Before 1974, all 403(b) accounts were required to be invested in annuities, which are essentially insurance products that act somewhat like investment accounts. Because of that, the term TSA, or tax-sheltered annuity, became a synonym for 403(b) plans in the popular jargon. In 1974, though, Congress opened the door for 403(b) plans to offer investments in mutual funds, which are investments in managed packages of stocks, bonds or both.
The difference can be important in one key aspect: expenses.
Pros and Cons of Annuities
Annuities are investment vehicles provided by insurance companies. Fixed annuities provide a return at a fixed rate of interest, while variable annuities grow roughly with the performance of underlying investment accounts, which - much like mutual funds - usually include a managed collection of stocks, bonds or both.
Annuities often include add-ons such as death benefits, which can guarantee that an account will pay at least a certain minimum amount to an account holder's survivors. And they usually contain the option of converting the investment into an annual payout in retirement.
Because of the add-ons, annuities tend to be more expensive to maintain than mutual funds. Many annuities also contain stiff charges for early cash-outs - as much as 7% in the early years of the investment. This can make them difficult to roll over into other retirement accounts or to cash out altogether.
Once Again, Check Expenses
Many 403(b) programs today offer their participants a selection of investment providers to choose from. Some include both annuity and mutual fund options. It's best to take a close look at each option's annual expense level, which can be found in its prospectus, before making a final choice. You may also need to make choices when it's time for you to decide whether to take withdrawals from an account.
In addition to being able to take penalty-free withdrawals after age 59 1/2, 403(b) participants can access their money without penalty if they retire during or after the year in which they turn 55. Money can also be accessed penalty-free if the participant becomes disabled, or if he or she retires before age 59 1/2 and opts to take what are known as "substantially equal periodic payments" - annual payouts at levels that are typically determined by IRS actuarial tables.
Penalty-free hardship withdrawals may also be possible to cover medical expenses, a down payment on a first home, higher education or to save a home from foreclosure, but it's best to check with a financial adviser before trying any of these moves.
