Understanding the Basics of a 403(b) Retirement Plan: A Comprehensive Guide

A 403(b) retirement plan, also called a tax-sheltered annuity plan, is a specialized retirement plan for employees of public schools and certain non-profit organizations. The plan, like a 401(k), is named after the section of the tax code that describes it. While a 403(b) is similar to a 401(k), there are a few key differences. Below, you'll find a comprehensive guide to 403(b) retirement plans, including eligibility requirements, advantages and contribution limits.

Overview: What is a 403(b) Retirement Plan?

A 403(b) plan is a retirement account designed to help you invest for retirement. If you work for a public school or are an employee of certain 501(c)(3) tax-exempt organizations, you might have access to a 403(b) instead of other retirement plans. Employees of public schools, such as teachers and administrators, government employees, medical professionals, librarians and self-employed ministers, may have access to 403(b) plans if they work for qualified organizations. 

A 403(b) account enables these employees to defer a portion of their paycheck for retirement. You can deduct contributions from your annual income and pay taxes when you withdraw funds at retirement. 

In addition to a standard 403(b), which is tax-deferred like a 401(k) or an individual retirement account (IRA), you could also have a Roth 403(b). In that case, you pay taxes on your contributions, and your money grows tax-free.

How Does a 403(b) Retirement Plan Work?

Like other retirement accounts, a 403(b) plan allows employees to save for retirement by contributing to individual accounts. Employers may also contribute to employees’ accounts. The accounts are tax-advantaged. Here are the key features you want to understand. 

Eligibility Requirements

To be eligible for a 403(b) plan, you must be an employee at qualified public schools, government agencies, churches or nonprofit organizations.  

Types of Plans

There are two types of 403(b) plans:

• Traditional 403(b) plan: You can deduct contributions from your taxable income and will pay taxes on withdrawals. 
• Roth 403(b) plan: With these plans, like a Roth IRA, you will pay taxes on all contributions; the funds grow tax-free. 

Tax Advantages and Considerations

There are significant tax advantages to 403(b) plans. With a standard 403(b), participants make pretax contributions, and earnings are not taxed until they are distributed from the plan. With a Roth 403(b) plan, you will pay taxes on contributions, but they grow tax-free. With many plans, you can choose either a standard 403(b) or a Roth 403(b). 

Contribution Limits and Withdrawal Penalties

Another major advantage is that contribution limits for 403(b) accounts are comparable to 401(k) contribution limits and much higher than IRA contribution limits. For 2023, you can contribute up to $22,500 yearly to a 403(b). If you also have a 401(k) plan, the limit applies to your total contributions to your 403(b) plus 401(k) in the same year. 

If you’ve worked for your employer for at least 15 years, you may make an additional $3,000 contribution past standard limits. However, there’s a $15,000 lifetime maximum on these additional contributions.

Investment Options

According to the IRS, assets in a 403(b) plan can be placed in the following investment types:

• An annuity contract from an insurance company
• A custodial account invested in mutual funds
• A retirement income account for church employees

Pros and Cons of a 403(b) Retirement Plan

There are significant advantages to 403(b) retirement plans, from the tax-advantaged growth to the higher contribution limits, but limited investment options can be a drawback for some. Here’s an overview of key pros and cons. 

What Are the Advantages of a 403(b) Plan?

• Tax advantages: Depending on the type of plan you choose, you’ll get tax-deferred or tax-free growth.
• Employer matching: Like a 401(k) plan, employers may match some personal contributions to help you maximize retirement savings.
• High contribution limits: Contribution limits for 403(b) accounts are much higher than IRA contribution limits.
• Shorter vesting schedules: Vesting schedules are how soon funds are yours even if you leave the employer. Some 403(b)s have immediate vesting, while most have shorter vesting schedules than 401(k)s. 
• Catch-up contributions: If you’ve worked for your employer for at least 15 years and you’re over 50, you can make up to $3,000 a year and $15,000 total in catch-up contributions. 

What Are the Disadvantages of a 403(b) Plan?

The disadvantages of a 403(b) plan center around investment options. Here’s what you should know: 

• Few investment choices: You won’t have as many choices compared to 401(k)s, IRAs or brokerage accounts.  
• High fees: While this is not true of all plans, some 403(b)s charge higher fees that can eat into your profits.
• Early withdrawal penalties: If you withdraw funds before age 59½, you’ll pay a 10% early withdrawal penalty plus applicable taxes.
• Not all 403(b) plans are subject to ERISA: The Employee Retirement Income Security Act sets reporting and fiduciary standards for employment plans. 

Optimizing Your 403(b) Plan

If you have access to a 403(b) plan with employer match, be sure to take full advantage of matching funds so you don’t leave possible retirement funds on the table. With a focused savings strategy, you could even retire early. Ready to do more? Learn how much money you need to retire, how to retire by 55 or find the best investments for retirees. 

Frequently Asked Questions