Fed/Non Profit

· 403(b)/TSA

· 457 Plan

For whom is the 403(b) designed?

Whether you are a schoolteacher, professor, a nurse or work for a non-profit group, you deserve to know about a retirement planning tool that can help you keep more of your hard-earned money through special tax savings available to you — a public service professional.

Retirement is a dream, a goal, something to plan for — an actual reward for our service we willingly render to the public.

We plan for our projects at work, we plan for our vacations, and we even plan for our free time when we are lucky enough to have it. So why is it not as easy to plan for a secure retirement future?

This part of the website addresses the opportunity public service professionals have to attain a more secure retirement future. In the following paragraphs you can learn about one of the most powerful financial planning tools available — the 403(b).

 

What is the 403(b) and how does it work?

The 403(b) is a retirement plan defined in and governed by Section 403(b) of the federal tax law. Commonly referred to as a TSA (Tax-Sheltered Annuity), the 403(b) is designed for employees of schools, colleges, universities, non-profit groups and other tax-exempt organizations such as hospitals. Unfortunately, many people do not know about the 403(b), even though it has been around for years. In fact, only 34% of eligible individuals participate in 403(b)s, in contrast to the 85% who participate in 401(k)s.

In the past, the rules governing 403(b)s were complicated and restrictive, but as of January 1st, 2002, the IRS changed the rules — allowing for greater contribution limits and providing greater catch-up provisions for persons age 50+ who have been in service for 15 years or more. The IRS also eliminated the Maximum Exclusion Allowance (MEA), which was a complicated, time-consuming form that figured earnings, number of years of service, etc. With the new rules, it is much easier to participate in a 403(b) and take advantage of important tax savings. Individuals elect to participate by simply filling out a Salary Reduction Agreement that instructs their payroll department to contribute a desired monthly amount into their 403(b) account. The contributions into a 403(b) are called “salary reductions” because the funds are taken out of an individual’s pay before taxes and are excluded from his or her current federal and state taxable income. The amount contributed into the 403(b) may be increased, decreased or discontinued at the request of the participant by simply filling out a new Salary Reduction Agreement and submitting it to the payroll department.

In 2001, individuals could only contribute up to $10,500 into their 403(b) annually. New IRS changes, however, have increased this annual limit to $11,000 for 2002. This limit will increase $1,000 each year until 2006, when the limit will be $15,000 annually.

For individuals who are at least age 50 and have 15 years or more of service and have not taken full advantage of the contribution limits in the past, there is a catch-up provision. The catch-up provision allows an employee to contribute from that which could have been contributed in previous years.
Because the funds contributed to a 403(b) are not included when calculating current taxable income, depending on the amount contributed and the number of dependents, your plan could lower your annual taxable income enough to cause you to fall into a lower tax bracket. In some cases, an individual may increase his or her annual net income by contributing to a 403(b).

 

How do 403(b) contributions affect take-home pay?

As a result of the tax savings linked to a 403(b), many people have discovered they are able to adequately save for their future retirement with only a minimum reduction in their take-home pay. For example, consider the case of a 28-year-old schoolteacher named Tracie. Tracie is married, has two children and earns $40,000.00 per year, so each month she receives a paycheck for $3,333.33. The following scenarios will demonstrate how Tracie’s take-home pay can be affected by contributing to a 403(b).

For the first scenario, assume that Tracie claims single with no dependents for federal and state taxes. In this scenario, Tracie chooses not to contribute to a 403(b), but every month $266.67 is automatically taken out of her pay before taxes for her employee pension plan. This means her net taxable income is $3,066.66. Then Tracie must pay FICA and Medicare, which is a set $255.00 per month. Lastly, because she is in a 20% tax bracket, she must pay $591.99 in federal and state taxes. This leaves Tracie $2,219.67 in take-home pay.

Now let’s change some of the factors and see how Tracie’s take-home pay is affected. For this scenario, assume that Tracie claims single with one dependent for tax purposes. Her pension plan deduction is still $266.67, but this time she also chooses to contribute $153.85 a month into a 403(b). From her $3,333.33 gross monthly pay, her net taxable income is now $2,912.81. She is now in a lower tax bracket, and her FICA and Medicare is still $255.00, but her federal and state taxes equal only $464.06 — which is a tax savings of $127.93. With these changes, Tracie’s take-home pay is $2,193.75. This means that by reducing her take-home pay by $25.92, Tracie was able to save $153.85 for retirement.

If Tracie were able to but $153.85 a month into her retirement account until age 60, she could expect a 403(b) account balance of $149,755.50, assuming a 5.25% interest rate.

Look what happens if a few more changes are made. For this final scenario, assume that Tracie claims married with two dependents for tax purposes. As usual, the $266.67 is taken out of her gross monthly pay for her pension plan, but this time, Tracie decides to increase her 403(b) contribution to $489.21. With these two pre-tax deductions, Tracie’s net taxable income has dropped to $2,577.45, which causes her to fall into an even lower tax bracket. She now only pays $199.93 in federal and state taxes, which is a tax savings of $392.06. With these changes, Tracie’s take-home pay is $2,203.28. This means that by reducing her take-home pay by just $116.49, Tracie was able to save $489.21 for retirement!

Even better, if Tracie were able to put $489.21 a month into her retirement account until age 60, she could expect a 403(b) account balance of $476,190.51! (Assuming a 5.25% interest rate.)

 

Why choose a 403(b)?

Whether you are interested in using a 403(b) alone or as an excellent addition to an existing pension plan, a 403(b) is one of the best retirement planning options available to public service professionals. With the new increase in limits, catch-up provisions and special tax savings, a 403(b) offers the advantages that will help you secure a future you can look forward to. Many 403(b) programs allow an individual to take out a loan, but it must be paid back within five years to avoid paying hefty taxes. In addition, as with other qualified plans, an individual may have to pay a 10 percent tax penalty* if funds are withdrawn before age 591/2. (*Refers to 10% excise tax imposed by the IRS for premature withdrawals.)

As you can see, planning for a secure and comfortable retirement future is possible and can be a simple process. A 403(b) may be used to fill retirement gaps and is one of the best tools available to lower taxes now and use the government’s money to help you earn interest for the future.

 

For whom is the 457 Plan designed for?

There are many people in our society who have careers that require a willingness to give of themselves through dedication and hard work. They serve others because they love it — and generally love the people they serve. These important individuals are our public service professionals — our firemen, police, government employees, teachers, medical professionals, non-profit and religious groups, etc.

Although the personal satisfaction and rewards received can make these career choices "worth it," many people are hesitant to pursue these careers because the financial benefits are often far better elsewhere. Yet these individuals who perform such an important role in our society certainly deserve a financially secure retirement — a retirement with dignity. This part of the website addresses the opportunity public service professionals have to attain a more secure retirement future. Congress has passed special tax laws specifically designed to assist public service professionals in preparing for retirement. The result is a retirement program called a 457 Plan. If you are a public service professional, you need to know about this simple method of keeping more of your hard-earned money through special tax savings.

 

What is the 457 Plan and how does it work?

The 457 Plan is a salary reduction plan similar to a 403(b). It is also known as a deferred compensation plan. Individuals participate by electing to have a certain portion of their salary deposited into an approved retirement fund vehicle, such as a fixed annuity. This monthly contribution is taken out of the pay before taxes and is therefore excluded from the current federal and state taxable income.

In 2001, individuals could only contribute up to $8,500 into their 457 Plan annually. New IRS changes, however, have increased this annual limit to $11,000 for 2002. This limit will increase $1,000 each year until 2006, when the limit will be $15,000 annually. Also beginning in 2002, individuals who are age 50 or older may contribute an additional $1,000 annually. Furthermore, there is a catch-up provision for individuals who are at least age 50 and have not taken full advantage of the contribution limits in the past. During the last three years of employment, the catch-up provision allows an employee to contribute up to $22,000.00, depending on how much they have contributed in the past. The maximum amount allowed is calculated by subtracting the actual amount contributed from that which could have been contributed in previous years. (The catch-up limits will reset if the employee leaves the job and begins employment with another eligible employer.)

In addition to the catch-up provision, people are also now allowed to contribute up to 100% of their pay (less FICA, Medicare, etc.,) as long as the total pay falls within the applicable limits. This option can be very attractive to an individual whose income is not needed to provide for the household.

Because the funds contributed to a 457 Plan are not included when calculating current taxable income, depending on the amount contributed, this plan could lower an individual’s annual taxable income enough to cause him or her to fall into a lower tax bracket. In some cases, an individual may actually increase his or her annual net income by contributing to a 457 Plan. As a result of the tax savings linked to 457 Plans, many people have discovered they are able to adequately save for their future retirement with only a minimum reduction in their take-home pay. Consider the value of contributing a portion of an individual’s monthly pay to a 457 Plan before taxes are taken out. A person in the 28% tax bracket who chooses to contribute $1,000 to his 457 Plan would save $385.80 in federal and state taxes. He is putting away $1,000 for his future retirement, but because of the 457 Plan tax savings, his true "out-of-pocket" expenditure is only $614.20. This means that an individual could contribute $12,000 a year to his 457 Plan, yet only reduce his annual take-home pay by $6,285.45. It’s like being given a free $5,714.55 every year toward retirement!

 

What are other advantages of the 457 Plan?

By contributing annually to a 457 Plan, an individual takes advantage of not only tax savings but also tax-deferred growth. Internal Revenue Code Section 72(e) states that interest earned in a retirement vehicle, such as a fixed annuity, is not taxable to the owner until it is withdrawn. As long as the funds remain within the retirement vehicle, the interest can accumulate completely tax deferred. This means that an individual can earn interest not only on the money he or she deposits into a 457 Plan, but also earn interest on the interest and interest on the money that normally would be paid in taxes.

This triple advantage of tax deferral found in 457 vehicles like fixed annuities can have a major impact on the ultimate value of a 457 Plan. For example, let’s look at the retirement savings accounts of a woman named Mary and a man named John. Both of these individuals are in a 28% tax bracket, and both are earning a 5% return on their money. Each year, Mary deposits $12,000 into a Certificate of Deposit, (a CD), and at the end of the year she must pay taxes on all the interest earned in her CD. At the end of 20 years, Mary’s retirement account balance would equal $348,472.07.

John, however, chose to deposit $12,000 a year into a fixed annuity. Because he benefits from tax-deferred growth, John does not have to pay any taxes at the end of the year, but is able to leave all of his earnings in his annuity to earn even more interest. At the end of 20 years, John’s retirement account balance would equal $405,804.55. That is $57,332.48 more than Mary would have, simply because John chose to take advantage of tax-deferred growth with a fixed annuity. It is true that John will have to pay taxes on funds withdrawn from his 457 Plan, but it is very likely that he will be in a lower tax bracket when he begins using these funds. Plus, by withdrawing his retirement account balance systematically over time, he would continue to benefit from tax-deferred growth.

Not only does the 457 Plan offer the benefits of tax savings and deferred growth, but also other unique benefits as well. For example, normally if money is withdrawn from a retirement account before the individual is at least 59 ½, the IRS imposes a 10% tax penalty*. With the 457 Plan, however, this 59 ½, 10% rule does not apply. (To qualify for a penalty-free withdrawal before age 59 ½, an employee must first cease employment prior to the distribution. *All references to the 10% tax penalty are referring to the 10% excise tax imposed by the IRS for premature withdrawals.) For lower-income employees, 457 Plan contributions could potentially qualify as a 10%, 20% or 50% tax credit, depending on the individual’s annual income level.

Lastly, employers may compensate their employees for accumulated vacation and sick leave by contributing directly to their 457 Plans. This contribution can only be made in the year of separation.

For those individuals who already have a 457 Plan, the new IRS changes give you more control over your assets. Beginning in January 2002, the IRS now allows event-driven rollovers of a 457 Plan into an IRA. Qualified events include retiring, changing employment as a federal employee to a state employee, leaving one school district to work for another, moving into the private sector, etc. By taking advantage of this tax-free rollover option, you can ensure that your assets continue to work for you.

 

Why choose a 457 Plan?

Piecing together a secure retirement plan can be a puzzling experience, as many options must be considered. But whether used in conjunction with another plan or used alone, the 457 Plan is one of the best retirement planning options available to public service professionals. With its special tax savings, tax-deferred growth and other unique benefits, the 457 Plan can help you enjoy the retirement lifestyle you deserve — a retirement with dignity.