The 403(b) Lifecycle
November 29, 2022
The word “lifecycle” refers to a series of changes in the life of a person, household, or organization. For example, the family lifecycle refers to stages ranging from unattached adults to marriage through retirement years and the death of both spouses. The military lifecycle refers to the stages that service members pass through from recruit delayed entry and basic training through veteran status and separation and/or retirement.
403(b) plans also have a lifecycle with 12 stages ranging from starting a job that provides access to a 403(b) through the distribution of remaining 403(b) assets to a deceased plan participant’s beneficiaries. Not everyone goes through every stage, however. For example, if someone selects a low-expense, A-rated “good vendor,” they can skip the stage of leaving a bad 403(b). Also, some participants never increase their initial savings contribution despite several “catch-up” opportunities to do so and required minimum distributions (RMDs) do not apply to Roth accounts.
This post briefly describes each of the twelve stages of the 403(b) Lifecycle. Inspired by the Consumer Financial Protection Bureau’s military lifecycle graphic, it captures a series of plan-related events that could last up to 70 or 75 years (e.g., a teacher that starts working at age 22 and lives to age 97). Research results, three “need to know” facts, and six take-away action steps conclude this discussion.
1. Start of School or Non-Profit Organization Job
The first lifecycle stage is a qualifying job. 403(b) plans are retirement savings plans offered by educational and tax-exempt organizations and churches. Eligible participants include public and private school teachers, administrators, and staff (e.g., janitors, cafeteria workers, bus drivers, bus mechanics, secretaries), employees of public and private colleges and universities and Native American tribal government schools, and ministers and other employees of IRS code 501(c)(3) organizations, including certain hospitals with tax-exempt status.
2. Learn About 403(b) Plan Availability
Some potential plan participants find out about 403(b)s before they actually start working, often as part of an orientation process where various financial topics (e.g., health benefits) and paperwork (W-4 form for tax withholding) are discussed. Others find out later, perhaps by overhearing conversations in the faculty lunchroom or when a high-commission 403(b) product salesperson approaches them with a sales pitch.
3. Select 403(b) Vendor and Complete Enrollment Paperwork
Plan participants will select a vendor from among those offered by their employer plan. They will then complete paperwork with the employer to authorize recurring payroll deductions, typically a percentage of gross income (e.g., 5% of pay every pay period). They will also complete paperwork with the vendor to agree to contract terms and select specific investments and asset allocation weightings for their portfolio. For example, 50% stock, 30% bonds, 10% real estate investments, and 10% cash equivalent assets.
4. Leave a Bad 403(b) Vendor, If Necessary
Many 403(b) participants do not learn about the fees charged by vendors who sell expensive, commission-based products until after they’ve started making contributions. Later, they get “403bwise” through lunchroom conversations, exposure to the 403bwise website and Facebook group, and other sources. It can be expensive and time-consuming to reverse course and exit a bad plan, a process likened to “ripping off a Band-Aid.” 403bwise has step-by-step instructions to get money out of a bad 403(b).
5. Adjust Asset Allocation, As Desired (Rebalancing)
Over time, especially when the stock market is volatile, asset class weights will shift. The objective of portfolio rebalancing is to get back to initial target asset class weights (see above example) by selling securities in an “over-weighted” class and/or depositing new savings in an under-weighted class. There is no immediate taxation within tax-deferred plans and some 403(b) vendors provide automatic rebalancing services.
6. Increase Contributions, As Desired
Throughout 403(b) participants’ careers, as they earn more, they may be able to save more, up to the maximum annual limit allowed by the IRS ($22,500 and $30,000 at age 50+ in 2023). Increased savings (e.g., from 4% to 6% of pay) can be done gradually to keep pace with salary increases or when a major household expense (e.g., car or student loan payments or childcare) ends.
7. 15-Year 403(b) Savings Catch-Up
403(b) plans have a unique catch-up savings opportunity for mid-career employees. Plan participants who work for the same employer for at least 15 years can contribute up to $3,000 more per year, up to a total of $15,000, if their plan permits. Over time, this additional savings can grow significantly (e.g., $15,000 extra saved from age 38 to 42 that grows for 20 years from age 42 to 62 with a 6% average return = $48,107). Note that not all employers make this catch-up provision available.
8. Age 50+ Savings Catch-Up
Workers age 50+ can make an additional $7,500 catch-up contribution to 403(b) plans on top of the maximum $22,500 for all workers, for a total of $30,000 in 2023. Ten $7,500 deposits made over a decade, earning 6% on average, would grow to $98,856. Both the “15-Year Rule” and age 50+ catch-up opportunities can be used at their respective ages without affecting each other.
9. Leave School or Non-Profit Job
At some point, plan participants leave the job that provides access to 403(b) savings. They may switch careers or exit via retirement. 403(b)s have a 10% early withdrawal tax (plus ordinary income tax) on withdrawals made before age 59½. Certain exceptions apply. Between ages 59½ and 72 (when RMDs must begin), money in 403(b) accounts can be withdrawn without penalty or left to grow. Some participants also transfer their 403(b) account balances to rollover IRAs.
10. Continued Growth of Savings
Some plan participants with pensions or other income sources may exit the labor force between ages 55 to 62. If they can leave their 403(b) untouched, it will have a decade (or more) of tax-deferred growth before RMD withdrawals start. Someone with $500,000 saved at age 60 would have over $1 million 12 years later assuming a 6% average return.
11. Start Taking RMD Withdrawals
Mandatory RMD withdrawals must begin no later than age 72 and are added to taxable ordinary income. To calculate RMDs, 403(b) participants take the balance in their account on December 31 of the previous year and divide it by the appropriate divisor for their age. IRS life expectancy tables in IRS Publication 590-B provide the divisors to use. More money can always be withdrawn but, of course, that money is taxed also.
12. Distribution of Remaining 403(b) Assets to Beneficiaries
Unspent 403(b) balances typically go to one or more named beneficiaries when an account owner passes. Beneficiaries selected by the account owner are legally entitled to receive all, or a designated portion, of the account balance. Beneficiaries can be individuals and/or charities. Contingent beneficiaries should also be named in the event primary beneficiaries predecease the account owner or disclaim assets.
Research Results
A key 403(b) decision in Stage 3 is Roth vs. traditional accounts. Roth 403(b)s are funded with after-tax dollars. This means that money is taxed prior to making savings deposits and qualified withdrawals (at age 59½+ from an account open at least 5 years) - including earnings- are tax-free. There are no RMDs!
A study conducted when Roth 403(b)s first became available in 2006 compared outcomes from Roth and traditional employer savings plans. The researchers found that the Roth accounts accumulate significantly more than traditional retirement accounts. In addition, if tax rates rise during retirement, the Roth option immediately proves superior.
Three (More) Things
403(b) plans lack an ERISA fiduciary standard to put “a client’s interests first” and about 75% of dollars invested in 403(b)s are in annuity products with high surrender charges and mortality and expense fees.
Most 403(b)s do not have employer match so plan participants with only high-cost annuity product vendors will not miss any “free money” by investing, instead, in Roth and/or traditional IRAs or 457(b)s.
Nobody knows what tax rates or their future tax bracket will look like when RMDs from traditional IRAs and 403(b)s are combined with a pension, Social Security, and other income sources. One way to hedge this risk is to divide savings contributions between Roth and traditional accounts during working years.
Six Smart Strategies
No. 1: Choose to Save (Lifecycle Stage #1) — Given pension and/or cost of living (COLA) cutbacks and a lack of Social Security for many teachers, personal retirement savings is vital for financial security in later life, whether in a 403(b) or elsewhere.
No. 2: Find Quality Vendors (Lifecycle Stage #3) — Available 403bwise resources (website, Facebook group, podcasts, office hours) can help users find a low-cost retirement savings account. Reach out to educate new teachers before annuity vendors can prey on them.
No. 3: Regroup and Move On (Lifecycle Stage #4) — Every day, teachers learn their 403(b)s are laden with fees that eat away at investment earnings. To add insult to injury, surrender charges compound the misery. Get help to extricate yourself from a bad 403(b).
No. 4: Play Catch-Up (Lifecycle Stages #7 and #8) — 403(b) plan participants have two opportunities to make additional savings contributions in mid-life. They can use one or both, which can result in tens of thousands of additional dollars in savings.
No. 5: Consider a Retirement Rollover (Lifecycle Stage #9) — When 403(b) participants no longer work for the employer where their 403(b) was opened (e.g., if changing jobs or retiring), they can roll over 403(b) monies into a traditional IRA (e.g., for better investment options).
No. 6: Review Beneficiary Designations (Lifecycle Stage #12) — Regularly reviewing primary and contingent beneficiaries for 403(b)s, IRAs, and other financial contracts is highly recommended. Use this worksheet to keep list all of your beneficiaries in one place.
In Summary
Plan participants’ 403(b) lifecycles are unique and reflect the decisions they make and actions they take. In addition, some people (e.g., late savers) complete the lifecycle steps in, say, 10 to 40 years versus 40 to 75 years for others (e.g., 22 year old teachers who begin 403(b)s and live to age 97).
Regardless of your individual 403(b) lifecycle scenario, enjoy the journey and reap the benefits of regular savings and compound interest over time.
This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.
...
Dr. O'Neill is the owner/CEO of Money Talk: Financial Planning Seminars and Publications where she writes, speaks, and reviews content about personal finance. She is a Distinguished Professor Emeritus at Rutgers University and a long-time 403(b) plan participant.