Do you approach tax season with great apprehension because you know that you’ll owe the IRS? No fears, you are not alone. Even if your employer takes taxes out of your check each pay period you may end up owing the government additional cash. Not a problem if you are able to stash cash for taxes. But if every cent goes toward living expenses, getting hit with a huge tax bill can wreck havoc on your finances.
It goes without saying that the more tax deductions you take the better. But what if you don’t have many write offs? Well, there’s good news. If you work for a nonprofit employer, opening a 403(b) might be the golden ticket to a lower tax bill.
What is a 403(b)?
A 403(b) plan is a type of retirement plan that works like a 401(k) plan. But unlike a 401(k) plan, a 403(b) is specifically designed for employees who work for a nonprofit employer. This includes those employed by a religious or charitable organization, a public school, a state college, a library, a nonprofit health clinic and other qualifying organizations.
If eligible, contributing to a 403 (b) plan offers an effortless way to prepare for your retirement years. Your employer deducts a specific amount from each paycheck and deposits this money into your account. In some cases, your employer will match your contributions. Contributions are invested and grow tax-free until the time of withdrawal.
There are annual limits to how much you can contribute to a 403(b). As of 2013, the IRS allows contributions up to $17,500. Additionally, there are catch-up provisions in place for certain employees. If you’ve worked with the same nonprofit employer for at least 15 years, you can contribute an additional $3,000 each year (a lifetime cap of $15,000). If you’re over the age of 50, you can contribute an additional $5,500 to your plan.
Tax Benefits of a 403(b) Plan
For anyone interested in lowering their tax bill, opening a 403(b) account with a nonprofit employer can help. Reducing your tax obligation is all about lowering your taxable income by means of write-offs and tax deductions. There are several ways to achieve this. For example, you can itemize your tax return and write off mortgage interest, mileage, business supplies and qualifying medical expenses. But realistically speaking, most people – especially employees – are not eligible for certain write offs.
If you work for a nonprofit employer and open a 403(b) plan, contributions can be made with pre-tax income. This is highly beneficial for tax purposes because contributes are not reported as taxable income. The lower your taxable income, the less you pay in income tax. And as your retirement account grows, you don’t pay taxes on interest, capital gains or dividends.
Understand, however, that tax deferment does not last forever. If you choose pre-tax contributions, you will pay ordinary income tax at the time of distribution when you retire.