What Is a 403(b) Retirement Plan?

A 403(b) plan — sometimes called a tax-sheltered annuity plan — is a type of retirement plan available to public school employees, certain ministers and employees of certain 501(c)(3) tax-exempt organizations. The plan allows workers and their employers to contribute to the plan.

What Is a 403(b)?

A 403(b) retirement plan is a tax-deferred retirement savings plan available to certain employees. Tax-deferred means you don’t have to pay income taxes on the money you put into it, but you do have to pay taxes on the money you withdraw from your 403(b) plan.

People Who Can Enroll in a 403(b) Retirement Plan
  • Employees of 501(c)(3) organizations — tax exempt nonprofit organizations considered public charities, private foundations or private operating foundations under the tax code
  • Public school employees (including those organized by Native American tribal governments)
  • State college employees
  • University employees
  • Eligible employees of a religious institution
  • Ministers employed by a 501(c)(3) organization
  • Ministers not employed by a 501(c)(3) organization, but who function as ministers in day-to-day professional responsibilities with their employers
  • Ministers who are self-employed

Once you join a 403(b) plan, you can opt to have your employer withhold a portion of your paycheck for the plan. Your employer can also opt to contribute to your plan as well.

These contributions are invested annuity contracts or mutual fund custodial accounts — a brokerage account that invests in mutual funds, stocks and bonds.

How Does a 403(b) Plan Work?

A 403(b) plan allows you to invest your money in funds with different levels of risk — from relatively safer investments to high risk ones.

Your contributions are taken out of your paycheck and invested in annuities or mutual funds within the plan. You choose the amount of your contributions and which investments in the plan you want to invest in.

You pay no income taxes on the contributions you make, but you pay taxes on the money you withdraw.

You can start withdrawing money from your plan starting six months after your 59th birthday. Before that, you have to pay 10 percent of the withdrawal as a penalty on top of the taxes on the withdrawal.

Did You Know?
If you have a 403(b) plan, your employer may give you a choice of how you will receive your benefits. You may be able to choose regularly scheduled withdrawals or a lump sum payment.

403(b) Contribution Limits

Contribution limits are the same for 403(b) plans as 401(k) plans. You are allowed to invest up to $19,500 in a 403(b) plan in 2020. The total of your contributions and your employer’s contributions to your plan is limited to $57,000 for the year.

If you are 50 or older, you can make so-called “catch-up” contributions — up to $6,500 in 2020.

If you work for certain nonprofits and have 15 years of service with your employer, you may be eligible to make an extra catch up contribution of up to $3,000 per year — up to a maximum of $15,000 over your lifetime.

What’s the Difference Between a 401(k) and a 403(b) Retirement Plan?

The main difference between a 401(k) and a 403(b) plan is based on where you work. A 403(b) plan will be offered by certain tax-exempt nonprofit organizations. A 401(k) plan will be offered at for-profit companies or organizations.

But there are other differences as well.

Differences Between 401(k) and 403(b) Plans
401(k)403(b)
Offered through for-profit organizations and companiesOffered through tax-exempt nonprofit organizations such as public schools, charities and foundations
Investment options include annuities, bonds, mutual funds and stocksAnnuities and mutual funds are the only investment options
Subject to nondiscrimination testing — annual tests to make sure the plan is offered to all employees, not just owners or highly-paid employeesNot subject to nondiscrimination testing
Your employer can match your own contributions into the planYour employer can match your own contributions, but is limited by rules laid out in ERISA (Employment Income Security Act of 1974)

In rare cases, employers may offer both a 401(k) plan and a 403(b) plan to their employees. In those cases, you and your employer may contribute to both plans.

Advantages and Disadvantages of a 403(b) Plan

A 403(b) plan offers tax advantages on saving for retirement. At the same time, the plans may not afford you the same protections as a 401(k) plan. It’s important to understand your organization’s plan as you plan for your retirement.

Advantages and Disadvantages of a 403(b) Plan
AdvantagesDisadvantages
Once you turn 50, you can make higher, additional “catch-up” contributions than someone with a 401(k).There is no nondiscrimination testing for 403(b) plans, meaning there’s no protection against upper level management or highly paid employees from reaping the most benefits from your organization’s plan.
You effectively get “free money” if your employer matches your contributions.Until six months after your 59th birthday, you face a 10 percent early withdrawal penalty for any money you take out of your plan.
You get a tax break, either deferring your taxes until you withdraw money from your plan or, if it’s a Roth 403(b), paying taxes on contributions now and paying no taxes on withdrawals later.You may face a much more narrow set of investment choices than someone with a 401(k).
You may actually own the money in your fund (something called “vesting”) sooner than someone with a 401(k). Some 403(b) plans allow for immediate vesting.Your invested funds don’t have the same protections against creditors as funds in a 401(k).

If your employment ends before you retire, you can take the money in your 403(b) plan with you without having to pay the 10 percent early withdrawal penalty. But you may have to rollover the funds into an IRA (individual retirement account).

Last Modified: September 17, 2020

4 Cited Research Articles

  1. U.S. Internal Revenue Service. (2020, March 20). Retirement Plans FAQs Regarding 403(b) Tax-Sheltered Annuity Plans. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-403b-tax-sheltered-annuity-plans
  2. U.S. Internal Revenue Service. (2020, February 12). Publication 571 (01/2020), Tax-Sheltered Annuity Plans (403(b) Plans); For Employees of Public Schools and Certain Tax-Exempt Organizations. Retrieved from https://www.irs.gov/publications/p571
  3. Moore, S. (2018, April 18). Pros and Cons of 403(b) Plans for Educators and Non-Profit Workers. Retrieved from https://www.forbes.com/sites/simonmoore/2018/04/18/pros-and-cons-of-403b-plans-for-educators-and-non-profit-workers/#4ff8b80a7ecf
  4. U.S. Securities and Exchange Commission. (n.d.). 403(b) and 457(b) Plans. Retrieved from https://www.investor.gov/additional-resources/retirement-toolkit/employer-sponsored-plans/403b-and-457b-plans