What Is a 403(b) Plan?
A 403(b) plan is a retirement plan for certain employees of public schools, tax-exempt organizations and ministers. Individual 403(b) accounts are established and maintained by eligible employees.
Accounts under a 403(b) plan can be one of the three following types:
- an annuity contract provided through an insurance company; these 403(b) annuity plans are also known as tax-sheltered annuities (TSA’s) and tax-deferred annuities (TDA’s).
- a custodial account provided through a retirement account custodian; investments are limited to regulated investment companies, such as mutual funds.
- a retirement income account, for which investments options are either annuities or mutual funds.
The employer may determine the financial institution(s) at which individual employees may maintain their 403(b) accounts.
Who can establish a 403(b) plan?
You are allowed to have a 403(b) plan if you are a:
- Public school, college or university or
- Charitable entity tax-exempt under section 501(c)(3) of the Code.
Why Establish a 403(b) Account?
The following are advantages of maintaining a 403(b) plan or account:
For the employer:
- attractive benefits that help keep high-quality employees happy.
- shared cost of funding between employers and employees (in some cases, only employees contribute to the 403(b) plan).
For the employee:
- reduced taxable income through pre-tax contributions.
- tax-deferred earnings on plan contributions.
- likelihood of paying less tax on assets as distributions usually occur during retirement, when an employee may be in a lower tax bracket.
- the ability to take loans from the 403(b) accounts.
403(b) Financial Hardship Distribution Rules
First and foremost, tax deferred savings plans such as 403(b)s, 401(k)s and 457s are designed to allow employees to save money for retirement while employed. They are considered long term investments and the IRS have imposed restrictions in the form of stiff penalties to discourage employees from accessing the funds in the account before retirement which are commonly called an “early or premature distribution”.
Generally, a distribution cannot be made from a 403(b) account until the employee:
• reaches 59 ½,
• has a severance from employment,
• becomes disabled,
• has a qualified reservist distribution, or,
• encounters financial hardship
For a distribution from a 403(b) plan to be on account of hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent or the employee’s non-spouse or non-dependent beneficiary.
Whether a need is immediate and heavy depends on the facts and circumstances. The IRS allows hardship distribution if it is used to pay for:
(1) certain medical expenses;
(2) costs relating to the purchase of a principal residence;
(3) tuition and related educational fees and expenses;
(4) payments necessary to prevent eviction from, or foreclosure on, a principal residence;
(5) burial or funeral expenses; and
(6) certain expenses for the repair of damage to the employee’s principal residence.
Expenses for the purchase of a boat or television would generally NOT qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.
A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children.
A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if:
(1) the employee has obtained all other currently available distributions and loans under the plan and all other plans maintained by the employer; and
(2) the employee is prohibited, under the terms of the plan or an otherwise legally enforceable agreement, from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution.
A hardship distribution may not exceed the amount of the employee’s need. However, the amount required to satisfy the financial need may include amounts necessary to pay any taxes or penalties that may result from the distribution.
Please note that hardship distributions are not necessarily exempt from an additional 10% tax penalty. In addition, withdrawals of this type are subject to federal income tax as they are viewed as ordinary income.
Proper documentation and Plan Administrator approval are required for financial hardship distribution applications.