403(b) Annuity Fixed Income Contract Rules

by Tom Streissguth
Public school teachers may have a 403(b) retirement plan.

Public school teachers may have a 403(b) retirement plan.

Hemera Technologies/AbleStock.com/Getty Images

Since 1958, the IRS has offered special tax treatment to the type of retirement account known as a 403(b). These accounts are available to employees of nonprofit organizations, cooperative health organizations and public schools, as well as qualified ministers. A 403(b) may come in the form of a custodial account (like an IRA), or a fixed-income insurance annuity.

Annuities

A 403(b) annuity contract offers a guaranteed rate of return to the owner, as long as the owner holds it until retirement. Typically, an insurance company will offer the annuity, which may be one of several options available to employees qualified for a 403(b). Employers may furnish a list of several different annuity providers to plan participants when they sign up.

Contributions

Employees as well as employers may contribute to a 403(b) annuity. Contributions are made pre-tax, meaning you do not pay taxes on those funds in the year you make the contribution. Elective deferrals are made through a salary reduction agreement with your employer. An IRS rule allows employees to make additional elective deferrals when they reach 15 years of service with the organization.

Contribution Limit

The IRS sets the rules for the annual maximum amount contributable, or MAC. The limit depends on the kind of contributions you and your employer made to the account during the year. The IRS sets limits on "annual additions" and "elective deferrals." If you contribute money only through a salary reduction agreement, your limit is the lesser of the limit on annual additions or on elective deferrals. If the only contributions were nonelective contributions made by your employer, the MAC is the limit on annual additions. If both kinds of contributions were made, the MAC is, again, the limit on annual additions.

Early Withdrawal

A 403(b) is an asset meant for retirement savings and income. To discourage any use of the money before you reach retirement age, the IRS penalizes early withdrawals, defined as any distribution taken before you reach age 59 1/2. Not only does the IRS slap a 10 percent penalty on the withdrawal, it also levies tax on the income earned by the annuity. Since your tax rate is generally higher when you're younger and earning a better income, this is an additional disadvantage to an early withdrawal.

Beneficiaries

An annuity contract is a form of life insurance, in which you name a beneficiary to whom the asset will pass on your death. The annuity's status as a component of a 403(b), tax-advantaged retirement account allows it to pass directly to the beneficiary without having to go through probate as part of the deceased's estate.