What Is a 403(b) Salary Reduction Agreement and How Does It Work?

A 403(b) salary reduction agreement is a valuable tool for employees of public schools, certain non-profits, and tax-exempt organizations to enhance their retirement savings. It allows participants to direct a portion of their pre-tax earnings into a retirement plan, reducing taxable income and promoting long-term financial security.

Eligibility Criteria

Individuals eligible for a 403(b) salary reduction agreement must work for organizations such as public schools, certain non-profits, or tax-exempt entities under Section 501(c)(3) of the Internal Revenue Code. These employees include teachers, school administrators, professors, researchers, librarians, and other staff members. Ministers employed by tax-exempt organizations or self-employed ministers may also qualify. Employers may impose additional requirements, such as minimum service or employment status, detailed in the plan’s governing documents. Employees are encouraged to review these documents to confirm their eligibility.

How to Enroll

To enroll in a 403(b) salary reduction agreement, employees should consult their employer’s human resources or benefits department to understand the plan’s features, including investment options and contribution limits. After reviewing the plan, employees must complete enrollment forms specifying contribution amounts, investment choices, and beneficiary designations. Evaluating one’s financial situation and seeking advice from a financial advisor can help determine an appropriate contribution level. Employees should confirm their payroll department has processed the salary reduction by reviewing initial paychecks and account statements.

Setting Contribution Amounts

Determining how much to contribute to a 403(b) plan involves balancing current financial needs with retirement goals. The IRS sets annual contribution limits, which for 2024 is $23,000, with an additional $7,500 for individuals aged 50 and older. Higher contributions can reduce taxable income, which may benefit employees in higher tax brackets. Younger employees may prioritize growth-oriented investments, while those closer to retirement may focus on stability.

Tax Aspects

Contributions to a 403(b) plan are made pre-tax, lowering taxable income for the year. Taxes on these contributions and earnings are deferred until retirement, when withdrawals are taxed as ordinary income. This can be advantageous if the retiree is in a lower tax bracket at that time. However, contributions are still subject to Social Security and Medicare taxes. Early withdrawals before age 59½ may incur a 10% penalty, with exceptions for specific circumstances.

Adjusting the Agreement Over Time

A 403(b) salary reduction agreement can be modified as financial circumstances or retirement goals change. Employees may adjust contribution levels in response to life events or changes in IRS limits. Employers typically allow adjustments at specific times, though some plans offer more flexibility. To make changes, employees must submit a revised salary reduction form. Regularly reviewing account statements and consulting a financial advisor can ensure contributions remain aligned with long-term goals. Employees should also review and adjust their investment strategies as they approach retirement.

Distribution Options

When accessing funds from a 403(b) plan, participants have several options. Periodic withdrawals provide steady income, while lump-sum distributions offer immediate access but may result in higher tax burdens. Partial withdrawals can help manage tax liability by spreading distributions over time. Rolling over the balance into an Individual Retirement Account (IRA) allows for continued tax-deferred growth and broader investment choices. Participants must comply with required minimum distribution rules starting at age 73 to avoid penalties. Strategic planning is essential when selecting a distribution method.