onyx investments / commentary
Like the 401(k) plan for Corporate America, it is the 403(b) plan that is a retirement income building block for academic and non-profit employees. For a comfortable retirement, many professors, administrators, and fundraisers will expect to grow their 403(b) plans into hundreds of thousands of dollars, if not, above $1 million. To realize these life goals, it is critical that this section of the workforce becomes very much familiar with the complex structure of the 403(b) plan and its contribution limits.
All retirement savings vehicles are notable for tax-deferral. Your 403(b) plan contributions are made with pre-tax money, which immediately lowers your current taxable income. Upon funding your 403(b), you will then purchase mutual funds that will grow on a tax-deferred basis, which means that you will not owe taxes on interest income, dividend payments, and capital gains, as they occur within the account. Future 403(b) distributions will be taxed as ordinary income.
403(b) tax deferral does introduce several caveats. Firstly, any withdrawals made before age 59 ½ will typically trigger a 10% additional tax penalty upon the total withdrawal. In most years, you would be required to take annual minimum distributions (RMDs) out of your 403(b) plan beginning at age 70 ½, in accordance with your account balance and life expectancy. For 2020, however, RMDs have been waived as part of the Federal CARES Act response to the coronavirus-related economic fallout.
For 2020, 403(b) contributions will be limited to $19,500 in elective salary deferrals. On top of this, your employer may also contribute into your 403(b) plan, for a combined $57,000 in total base contributions. Your employer may contribute up to 25% of your salary for the year as a matching contribution. In all, the $57,000 base contribution limit is not to exceed 100% of your employee compensation for the year. Going forward, taxpayers can expect annual 403(b) contribution limits to increase by $1,000 every year.
The 15-year service rule is unique to the 403(b) plan and its associated church, welfare-service, healthcare, and academic employees. As its namesake would imply, the 15-year service rule allows for workers with at least 15 years of service at the same institution to make additional, catch-up contributions. In IRS-speak, these catch-up contributions will be the lesser of $3,000, $15,000 – reduced by the amount of additional elective 15-year rule deferrals made in earlier years, or $5,000 times the number of years of service at the organization – minus the total elective deferrals made in prior years.
We recommend that you consult with your director of human resources to remain compliant with the 15- year service rule. At most, you will be able to make $22,500 in 2020 elective salary deferrals ($19,500 + $3,000), in keeping with the 15-year service rule. Be advised further that total employee / employer contributions would still be capped at $57,000 for the year – with only the 15-year rule in effect.
For 2020, taxpayers that turn 50 years old by the end of this year may make an additional $6,500 in catch- up contributions above the base and 15-year service amounts. In all, a diligent saver approaching retirement would max out his 403(b) at $63,500 in total (employee + matched) pre-tax contributions this year.