What Is a 403(b) Plan?


A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for employees of public schools, employees of certain tax-exempt organizations.
Individual accounts in a 403(b) plan can be any of the following types:

  • An annuity contract, which is a contract provided through an insurance company,
  • A custodial account, which is an account invested in mutual funds


What Are the Benefits of Contributing to a 403(b) Plan?


There are three benefits to contributing to a 403(b) plan.

  • The first benefit is that you do not pay current income tax on allowable contributions until you begin making withdrawals from the plan, usually after you retire. Allowable contributions to a 403(b) plan are either excluded or deducted from your income. However, if your contributions are made to a Roth contribution program, this benefit does not apply. Instead, you pay current income tax on the contributions to the plan but distributions from the plan (if certain requirements are met) are tax free. Tax penalties and penalties for early withdrawal may apply if funds are withdrawn prior to age 59 1/2.
  • The second benefit is that earnings and gains on amounts in your 403(b) account are not taxed until you withdraw them. Earnings and gains on amounts in a Roth contribution program are not taxed if your withdrawals are qualified distributions. Otherwise, they are taxed when you withdraw them.
  • The third benefit is that you may be eligible to take a credit for elective deferrals contributed to your 403(b) account.

Excluded. If an amount is excluded from your income, it is not included in your total wages on your Form W-2. This means that you do not report the excluded amount on your tax return.
Deducted. If an amount is deducted from your income, it is included with your other wages on your Form W-2. You report this amount on your tax return, but you are allowed to subtract it when figuring the amount of income on which you must pay tax.

What Is a 401(k) Plan?


This qualified retirement plan allows eligible employees to contribute a certain amount of compensation on a pre-tax basis; earnings are tax deferred. Employers may match a stated percentage of employee contributions to the plan. In many cases, employees have general responsibilities for investment choices and enjoy the direct tax deferred savings.


What is an IRA?


A lot of people mistakenly think an IRA itself is an investment – but it’s just the basket in which you keep stocks, bonds, mutual funds and other assets. An Individual Retirement Account (IRA) allows individuals to direct pretax income, up to specific annual limits, toward investments that can grow tax-deferred (no capital gains or dividend income is taxed). Taxes must be paid upon withdrawal of any deducted contributions plus earnings and on the earnings from your non-deducted contributions. Prior to age 59 1/2, distributions may be taken for certain reasons without incurring a 10% penalty on earnings.


Unlike 403(b) or 401(k) plans, which are accounts provided by your company, the most common types of IRAs are accounts that you open on your own. Others can be opened by self-employed individuals and small business owners. There are several different types of IRAs, including traditional IRA and Roth IRA.


What is the difference between Traditional and Roth IRA?


The main difference is when you pay income taxes on the money you put in the plans. With a traditional IRA, you pay the taxes on the back end – that is, when you withdraw the money in retirement. You may also be able to deduct your traditional IRA contribution, thus reducing your current taxable income. If you are a part of an employer–sponsored pension plan, and your income is above a certain limit, you may not deduct your traditional IRA contribution. Therefore, most educators are not eligible for a deductible traditional IRA.
With a Roth IRA, it’s the exact opposite. You pay the taxes on the front end, but there are no taxes on the back end.
There are other differences too. While almost anyone with earned income can contribute to a traditional IRA, there are income limits for contributing to a Roth IRA.
With a Roth IRA, you can leave the money in for as long as you want, letting it grow and grow as you get older and older. With a traditional IRA, by contrast, you must start withdrawing the money by the time you reach age 70½.


What is a Non-Qualified annuity?


A non-qualified annuity is not part of an employer provided retirement program and may be purchased by any individual or entity.
Contributions to nonqualified annuities are made with after-tax dollars and are not deductible from gross income for current income tax purposes.
Interest (or earnings in a variable annuity) is tax-deferred and only interest is taxable upon withdrawal.
Generally, withdrawals from a non-qualified annuity a subject to LIFO IRS rules – last-in-first-out, therefore taxable interest is withdrawn before principal.


What is an annuity?


An annuity is a contract between a policyholder and an insurance company that is designed to meet retirement and other long-range goals, under which the policyholder makes a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to the policyholder beginning immediately or at some future date. However, once the withdrawal penalty period has ended, the policyholder is able to withdraw funds without a company penalty.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay surrender charges to the insurance company, as well as tax penalties.
There are generally three types of annuities — fixed, indexed, and variable.
In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. Fixed annuities have no internal fees or charges.
The ability for the insurance company to meet these obligations to policyholders are subject to sufficient capital, liquidity, cash flow and other resources of the insurance company.


In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance. Indexed annuities are not securities. Interest payments are contractual obligations of the insurance company. Refer to policy for specifics regarding when interest is credited (usually only for funds held for a specific term) and how interest is calculated (may be less than actual index due to expenses and exclusions of dividend earnings of the index). Past performance of the index is no guarantee of future changes in the index or of future indexed interest earnings. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. Investors cannot invest directly in an index.


In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.

Actual investment return and principal value of both investments will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Variable annuities differ from mutual funds in that they provide lifetime income payments and death benefit protection. The separate account of a variable annuity is not a mutual fund. While separate account may have a name similar to a mutual fund, it is not the same pool of funds and will experience different performance than the mutual fund of the same or similar name.


What is a mutual fund?


An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and/or income for the fund’s investors.

A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified* portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund’s current net asset value (NAV) per share.


* Diversification does not guarantee a profit or protect against a loss.


What is a stock?


A stock is an ownership share in a corporation. Each of these shares denotes a part ownership for a shareowner, stockholder, or shareholder, of that company. Stocks are traded on exchanges all over the world; the largest is the New York Stock Exchange or NYSE. Stocks are identified by their ticker symbol. For example, General Electric is identified as GE, and Nordstrom is shown as JWN. Investors can buy a share in companies, or a share of a diversified* global portfolio of stocks. Individual investors can purchase shares for themselves, at a brokerage of their choice, or direct from the company; wherever they have an account set up.


There are different types of shares: common, preferred and unlisted. Most shareholders purchase common stock. The goal is for capital appreciation, as well as income from interest and dividends. The investor tries to beat the rate of inflation and Treasury Bills, but may end up with a profit or loss.


* Diversification does not guarantee a profit or protect against a loss.


What is a bond?

A Bond is simply an ‘IOU’ in which an investor agrees to loan money to a company or government in exchange for a predetermined interest rate.
If a business wants to expand, one of its options is to borrow money from individual investors, pension funds, or mutual funds. The company issues bonds at various interest rates and sells them to the public. Investors purchase them with the understanding that the company will pay back their original principal (the amount the investor loaned to the company) plus any interest that is due by a set date (this is called the maturity date).


A bondholder is mailed a check from the company at set intervals. In the United States, it is common for bonds to pay interest twice a year. In some other countries, bonds pay interest once a year. Still other bonds can pay monthly interest. The rate of interest a bondholder earns depends on the strength of the corporation that issued the bond.
For example, a blue chip is more stable and has a lower risk of defaulting on its debt. When companies such as Exxon Mobile, General Electric, etc., issue bonds, they may only pay 7% interest, while a much less stable start-up pays 10%. A general rule of thumb when investing in bonds is “the higher the interest rate, the riskier the bond.”Governments, municipalities, a variety of institutions, and corporations can issue bonds.There are many types of bonds, each having different features and characteristics. A few of the most notable are zero coupon and convertible bonds.


This is a hypothetical example for illustrative purposes only and does not reflect the actual return of any investment. There can be no guarantee that any particular yield or return will be achieved from any investment. Past performance is not indicative of future results. In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities). Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Lower-quality fixed income securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss.