In this article, we're going to be reviewing the 403(b) contribution rules that have the greatest impact on a plan's participants. That discussion is going to include elective deferrals, after-tax contributions, maximum allowable contributions, as well as the 15-Year Rule. There are only two sources of money that can be directed to a 403(b) account: a salary reduction agreement, or an employer making contributions directly to the fund itself. Even though an employee can specify the paycheck contributions to their 403(b) plan, only an employer can make the actual contributions to their account. Plan participants cannot make direct deposits into this kind of retirement plan.
Contributions to 403(b) Accounts
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This last point is subtle, but it's also an important one. Unlike a Roth IRA plan, individuals cannot wake up one day and decide to contribute $3,000 to their 403(b). The money has to come out of a paycheck each week, and the employer establishes the account payments based on the employee's instructions. That being said, there are three distinct ways to contribute to a 403(b) plan, including any combination of the below methods:
Elective Deferrals
Elective deferrals are contributions made under a salary-reduction agreement. This agreement allows an employer to withhold money from a paycheck to be contributed to a 403(b) account. Elective deferrals are not taxed until withdrawn from the account.
Non-Elective Contributions
Non-elective contributions are employer contributions, and do not require a salary-reduction agreement. These can include matching contributions, discretionary contributions, and even mandatory contributions to the employee's account as part of the overall policies established by the plan. As was the case with elective deferrals, non-elective contributions are not taxable until withdrawn.
After-Tax Contributions
The final way that funds can be directed into a 403(b) account is through after-tax contributions. If the plan allows, then these salary payments are taken from the employee's paycheck on an after-tax basis. Plan participants cannot deduct this type of contribution from their federal income taxes, however upon withdrawal, the taxed portion of the contribution will not be taxed again (but any appreciation, or growth, of this money over time will be taxed).
Annual Contributions to 403(b) Accounts
There are limits to the amount of money that can be placed into a 403(b) account each year. If a participant contributes too much to their account, then certain tax penalties may apply. Normally, the program administrator will automatically prevent employees from over-funding their accounts, thereby shielding them from any penalty.
Maximum Allowable Contributions or MAC
In general, individuals need to take into consideration two components of their maximum allowable contribution, or MAC, to understand what limits may apply in a given year. Those two components include the limit on annual additions (those made by the employee and others made to the account), and the limits on elective deferrals (funding from a paycheck).
The exact limit that applies depends on the types of contributions made to an account each year. In general, the limit to a 403(b) will be the lesser of the employee's annual additions, or their elective deferrals.
Only Elective Deferrals
If the only contributions made to a 403(b) were elective deferrals, then both of the limits mentioned above need to be calculated. The MAC will be the lower of the two limits calculated.
Only Non-Elective Contributions
If the contributions made to a 403(b) account were non-elective (employer contributions to an account), the MAC will be determined by calculating the limit on annual additions.
Elective and Non-Elective Contributions
If contributions to a 403(b) account include both elective and non-elective monies, then participants will need to calculate both limits, however, the MAC is the limit on annual additions.
Calculating a MAC
Plan participants should calculate their MAC each year based on their actual compensation. It is advisable to use a conservative estimate of compensation when calculating a MAC. If the employee's compensation should change during the calendar year, they can recalculate a new MAC based on this better information.
Annual Additions
The first component of the MAC calculation is the limit on annual additions. This is the limit on all contributions to a 403(b) account, and includes:
Elective Deferrals
Non-Elective Funds
After-Tax Fund
The limit in 2020 for annual additions was the smaller of $57,000 or 100% of includable compensation. In 2021, the limit for annual additions increases to $58,000 or 100% of includable compensation. In 2022, this limit will be indexed for inflation and can move up in $1,000 increments. Note: Updates to contribution limits are generally available in mid to late October.
Elective Deferrals
The 2020 and 2021 limit on elective deferrals to a 403(b) is $19,500. In 2022, the limit can move up in $500 increments based on a measure of inflation. There is, however, one exception to this guideline that is known as the 15-Year Rule.
15-Year Rule
If an employee has at least 15 years of service, then the limit on the elective deferrals to their 403(b) is increased by the lower of:
$3,000
$15,000 - reduced by the increases to the limit they were allowed in earlier years because of the 15-year rule.
$5,000 times the number of years of service they have with the organization minus the total elective deferrals made by an employer in earlier years.
Catch-Up Contributions
Finally, anyone reaching the age of 50 or older by the end of any calendar year may be eligible to make additional catch-up contributions to their 403(b) account. These catch up contributions cannot be made with after-tax money, and the maximum catch-up participants can make in 2020 and 2021 is $6,500, or their includable compensation minus their other elective deferrals for the year. In 2022, the rule for catch-up contributions is similar to the ones mentioned earlier; they can be indexed to inflation, and will move up in $500 increments. Keep in mind that catch-up contributions are not used when calculating a MAC. This means the maximum an employee is allowed to contribute to their 403(b) account is their catch-up plus their MAC.
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