Roger Rogers, 46, works for the local public school teaching Physics to advanced science high school students. Roger has been with the school for 21 years, earns $65,000 per year, and has never contributed to the 403(b) retirement plan that is offered. The 403(b) plan offers dollar-for-dollar matching on all contributions. The school district is considering adopting a 457 plan.
1. Which plan will offer Roger the highest tax deferral in 2020?
Under the 403(b) plan, the Internal Revenue Code (IRC) under its Section 415 and 402(g) has imposed limits to the amounts that may be deferred by participants according to their age and years of service in employment. Given that Rogers is 46 years old with a total work experience of 21 years, the 403(b) as per the year 2020 can enable him to make the deferred contributions as below.
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The regular limit allowed for the year 2020 is $19,500 for participants under 50 years of age. However, there is a special catch-up provision provided for participants with 15 or more full years of service given that their total cumulative 403(b) Plan is less than $5,000 times their years of employment.
Rogers qualifies for the catch-up provision given that he has served as a teacher for 21 years and has not made any contributions to the 403(b) Plan. Therefore, under the 403(b) Plan, the maximum Rogers can contribute for the year 2020 shall be;
$19,500 + $3,000 = $ 22,500
The Internal Revenue Code (IRC) also provides for the 457 Plan under its provisions in Section 457 which allows for tax-favored treatment of contributions for eligible employees of tax-exempt and governmental employers (IRC, 2020).
Under the 457(b) plan, a participant is allowed to pay the lesser of their includible compensation or the maximum amount of elective deferral of $19,500 as per the year 2020. This plan only allows for additional contributions of up to $6,500 for participants of 50years of age or more for the year 2020 (Waldrop, 2019). Under this plan, Rogers can only defer a maximum of $19,500.
Therefore, the plan that will allow Rogers to make the maximum tax deferral for the year 2020 is the 403(b) Plan that gives him a total tax deferral of $22,500.
2. If Roger’s wife makes enough money for them to live on and they decide to save as much of his income as possible, how much is the maximum that he can defer in tax-deferred retirement savings vehicles assuming the school adopts the 457 plan?
Under the 457 plan, Rogers can only differ the statutory limit of $19,500 for as long as he is still under 50 years of age irrespective of whether the wife’s money can take care of their needs or not.
However, at the age of 50 and above, Rogers will be in a position to save more. Having not contributed anything in the past, he will be eligible of making additional contributions of $6,500 per year on top of the $19,500 yearly limit. Additionally, once Roger’s age is within three years of the normal retirement age, he will be eligible for an increased limit of up to double the amount of yearly contributions. Therefore, within three years of the normal retirement age, Rogers will be eligible to make contributions of up to; ($19,500 x 2) = $39,000 per year. Furthermore, Rogers can decide to take advantage of the catch-up provision to defer more contributions. The catch-up provision allows a participant to defer the lesser of; twice the general limit for the year or the general limit for the year plus the amount the contributor could have deferred in prior years but did not.
3. What type of investments is Roger permitted to make in the 403(b) plan?
Roger has a limited number of investment choices under the 403(b) Plan. The most common type of investment option under the plan is the annuity contracts mostly provided by insurance companies. Rogers can also invest in mutual funds through custodial accounts provided by insurance or third-party agents who specialize in investing in a range of asset classes to minimize risks while ensuring maximum returns.
4. What type of employers may adopt a 403(b) plan?
The 403 (b) Plan may be adopted by employers that only permitted to do so by the law and they include; tax-exempt organizations as provided under the provisions of Section 501(c)(3), public schools, cooperative hospital service organizations, Uniformed Services University of Health Sciences, churches or qualifying church-controlled organizations, and self-employed ministers.
5. What types of employees benefit the most from the implementation of a 403(b) plan?
Implementation of the 403(b) Plan mostly benefits employees who have served long in their organizations to be eligible for more deferrals by working for more than 15 years. The plan also benefits those who are 50 years of age and above as it allows them the provision to increase their tax deferrals through the catch-up provision. The plan also benefits employees of not-for-profit organizations and churches that are tax-exempt. Tax deferrals through contributions by such employees enable them to enjoy future nontaxable income payments making them enjoy maximum value and benefits of the plan.
References
IRC. (2020). IRC 457b Deferred Compensation Plans: Internal Revenue Service. Retrieved from https://www.irs.gov/retirement-plans/irc-457b-deferred-compensation-plans
Waldrop, D. (2019). How 403(b) and 457 Plans Work Together. Retrieved from https://www.theastuteadvisor.com/403b-and-457-plans-work-together/
