Making sense of employer retirement plans

If your workplace offers a retirement investment plan like a 401(k) or a 403(b) – a type of account that’s available exclusively to nonprofit employees – you probably know that it’s a smart move to opt in, but you might not know why. In short: They give you a big financial advantage for the future, including (if you’re fortunate) free money from your employer.

All of these plans include a tax benefit of some kind; oftentimes, employers encourage retirement investment by matching your contribution (up to a certain limit). Some employers automatically enroll new employees in such plans, but typically you’ll need to take the first step and enroll yourself. When you sign up, you’ll need to choose the amount you wish to contribute from each paycheck, and where you want the money invested.

The 411 on 401(k), 403(b), and 457(b) plans

More often than not, when you hear about retirement plans, you’re hearing about a plan for for-profit employers called a 401(k). There are two types, one which provides a tax benefit up-front, and the other when you begin withdrawing your savings:

• Traditional 401(k)s are employer-sponsored plans that give employees a choice of investment options. Employee contributions to a 401(k) plan, and any earnings from the investments, are tax-deferred. That means the money you invest is taken from your earnings before they’re taxed, but you’ll end up paying taxes on the savings as they’re withdrawn. As a benefit, some employers will match employees’ 401(k) contributions up to a certain point; taxes on these matching funds also are deferred until savings are withdrawn.
• Roth 401(k)s are similar to a traditional plan, with one major exception: Contributions by employees are made with after-tax dollars. However, that means you will not pay taxes on your savings when you withdraw them, and any income earned on the account – be it from interest, dividends, or capital gains – is tax-free.

As a nonprofit employee, you will be eligible for the nonprofit version of the 401(k), called a 403(b) or a 457(b). These plans are tax-deferred retirement savings programs, like the traditional 401(k); 403(b)s are provided by employers like public educational institutions, certain nonprofits, and churches or church-related organizations, while government employers (state and local) and certain nonprofits may offer 457(b) plans. Some employers offer both 403(b) and 457(b) plans, and allow contributions to both.  

Similar to 401(k) plans, 403(b) and 457(b) plans allow you to contribute pre-tax money from your paycheck; these pre-tax contributions and their investment earnings will not be taxed until you withdraw the money, typically after you retire.

One major difference between the for-profit 401(k) and the two nonprofit plans is that, each year, the IRS determines annual contribution limits for both 403(b) and 457(b) plans. For instance, in 2017, the annual contribution limit for both 403(b) and 457(b) plans was $18,000. In addition to that amount, however, both plans allow additional “catch-up contributions” of up to $6,000 for those turning 50 or older. To review the specific rules governing contribution limits and catch-up contributions, check the IRS webpages for 403(b) contributions and for 457(b) contributions.

In addition, tax consequences differ between 403(b) and 457(b) plans, so be sure to get advice specific to your plan from a tax professional. You can find more general tax information about these plans on the IRS website: for the 403(b) here, and for the 457(b) here.

Adapted from this piece and this piece on Investor.gov and this piece on Investopedia.com

FOR MORE INSIGHT

On employer retirement plans
Employee benefit questions you need to ask before you enroll (Human Interest)
457 plans versus 403(b) plans: A comparison (Investopedia)

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