What Is a 403(b)?

There are a variety of different types of retirement saving solutions available to employees both in the public and private sectors. If you work at a public school, charity, or church, you may be eligible to participate in a 403(b), a tax-deferred retirement plan that lets you save a portion of your paycheck.

According to the U.S. Government Accountability Office (GAO), Americans held about $1.1 trillion in 403(b) plans as recently as 2020. In this article, we’ll detail how these plans work, who they’re for, and the basics around both contributions and distributions. Finally, we’ll outline the important pros and cons of using these plans.

How 403(b)s Work

Also known as a tax-sheltered annuity (TSA), a 403(b) is a defined contribution plan that allows you to defer some of your salary on a pre-tax basis and then withdraw it upon retirement age. The following groups of people are typically eligible to participate:

• Public educators (i.e., employees of public schools, state colleges, and universities)
• Employees of 501(c)(3) charitable organizations
• Church employees

Much like the 401(k), a retirement saving account for private sector employees, you’ll be able to invest the money you’ve allocated out of your salary within your 403(b) account. Often, you’ll have a specified range of investments to choose from, including mutual funds and annuity contracts.

As of 2024, you can contribute up to $23,000 to your account from your yearly salary. Additionally, your employer may, at its discretion, also put money into your account. This may vary from organization to organization; however, a common amount might be about 5% of your salary. Keep in mind, though, that the limit for employee and employer contributions combined is $69,000.

Distributions

As you contribute to your 403(b), your money grows over time, tax-deferred, by way of compound interest and your investments. Once you reach 59.5 years old, you’ll be able to begin withdrawing funds from your account. If you elect to take distributions before this age, you’ll face a 10% excise penalty and be subject to federal and state income taxes (if your state has them). One common exception to this rule is if you leave your job, which enables you to make withdrawals at 55 years old.

There may, depending on your plan, be cases where you could access the funds within your account early. For example, according to the Internal Revenue Service’s (IRS) documentation on the subject, your employer may allow you to take loans from your 403(b). You may also be able to take hardship distributions at no penalty.

It’s important to note that traditional 403(b)s and Roth-designated accounts in 2023 and 2022 are subject to required minimum distributions (RMDs). If you’ve turned 73 years old and still have funds in your account, the IRS will require you to distribute a specified amount of money per year. From 2024 onward, Roth 403(b)s are not subject to RMD requirements.

Types of 403(b)s

There are two types of 403(b) accounts you can have, each with different tax implications to consider. The first, a traditional account, operates on a tax-deferred basis where you must pay taxes once you start withdrawing. The other, a Roth-designated version, allows you to allocate after-tax funds from your paycheck and withdraw them tax-free:

Below is a more specific breakdown of each:

Traditional 403(b)

Under a traditional 403(b) arrangement, the money that goes into your account will come from your paycheck before withholding taxes. Then, when you reach the age where you can begin making distributions, you must pay income tax upon withdrawing your savings from the plan.

Roth 403(b)

Conversely, with a Roth 403(b), your savings get taxed applicably before they enter your account. Therefore, when you turn 59.5 and become eligible to make withdrawals, you won’t need to pay income tax on any distributions.

If your employer allows you to use a designated Roth account, there are, however, some important additional qualifications you must meet before you’re able to access your money. Specifically, you must meet the five-taxable-year participation period requirement, which means that five years have passed before you made your first contribution to the account.

Catch-Up Contributions

Catch-up contributions are an effective option commonly available in retirement plans that allows you to put an additional amount of money in as you get older. If you’re 50 years old or older, the IRS allows you to make catch-up contributions within your 403(b) account up to $7,500 as of 2024. You can also make perform catch-up contributions if you’ve gained 15 years of experience with your employer. In this case, you’ll be able to put in an extra $3,000 per year, up to a total of $15,000. For more clarity on these rules and requirements, we recommend talking to your plan administrator or consulting the IRS’s page on the topic.

Pros and Cons of 403(b) Plans

403(b)s can be highly useful saving tools for retirement. They enable your money to grow with compound interest and through investment vehicles, such as mutual funds and annuities. However, these types of accounts can also have some disadvantages to keep in mind, especially as you weigh which plans best fit into your retirement plan.

Here are the pros and cons to consider:

Pros

• Tax advantages. 403(b)s are either tax-deferred with a traditional account or tax-free with a Roth designation, each providing a unique set of benefits.
• High contribution limits. Like its cousin, the 401(k), 403(b)s have high annual contribution limits that allow you to stow away significant amounts of money into your account.
• Catch-up contributions are available. If you’re eligible, you can make large catch-up contributions to add even more funds to your plan.
• Employer contributions and matching. Employers often provide matching depending on how much you put in or, in other cases, offer fixed contributions regardless of whether you contribute.
• Includes professionally managed investments. These accounts often have a set of investment options overseen by a plan administrator and professional managers, allowing you to invest with more guidance than doing it on your own.

Cons

• Early withdrawal penalties. Besides a few exceptions, such as for financial hardship, accessing your money before reaching 59.5 years old comes with high penalties.
• High fees. Some plans may come with high fees for maintenance or expense ratios for active fund management.
• Limited investment options. You’re at the mercy of the investment menu your plan offers. Annuities, for example, are an especially common option.
• Some plans are not governed by the Employee Retirement Income Security Act of 1974 (ERISA). In some cases, 403(b) plans are exempt from ERISA and, thus, don’t need to follow the same standards.

Frequently Asked Questions

What is the difference between a 403(b) and a 401(k)?

While 403(b)s and 401(k)s are similar retirement vehicles, both allowing employees to save on a tax-deferred basis from their paycheck with investment options, they differ primarily in who they’re for. 401(k)s are mainly available to employees of private sector corporations. On the other hand, 403(b)s are for certain types of public sector employees, including those working in education, at non-governmental organizations (NGOs), and churches.

Can I roll over my 403(b) to another retirement plan?

Yes, the IRS permits you to roll your 403(b) into another retirement plan, such as a traditional IRA or Roth IRA; however, you must do so within 60 days. Otherwise, your funds will be subject to the 10% tax penalty for early withdrawals. For more information on what you can roll your 403(b) into, the IRS provides a useful rollover chart, available in PDF format.

What happens to my 403(b) after leaving my employer?

When you leave your employer, what happens to your 403(b) plan will generally be up to you. You can opt to keep the account in place until you reach retirement age; however, be aware that you won’t be able to make any additional contributions. This is probably one of the more cost-effective options, as you don’t risk taking on any withdrawal penalties.

You could also, as noted, roll your plan into another type of retirement account. However, you’ll need to make sure you follow all applicable requirements to ensure this goes smoothly. In this case, it may be helpful to consult the help of a financial advisor to avoid any costly mistakes.

Finally, you can simply take the money out of the account. Be aware, though, that this means you’ll incur a 10% penalty. Therefore, you’ll get a significantly lower amount of cash than you likely would’ve if you left the account in place. However, if you prefer to have an injection of cash, this is always an option.