A 401(k) is often praised as one of the best retirement plans for growing long-lasting wealth. Still, employees of nonprofits, public education institutions, and certain religious organizations have their own robust savings vehicle: a 403(b) plan.
But what exactly is a 403(b) retirement plan and how does it compare to other retirement savings vehicles?
Our 403(b) guide explores the ins and outs of how to save for retirement with a 403(b) plan, its contribution limits, and the investment options available to you.
Introduction to 403(b) plans
Definition of a 403(b)
A 403(b) plan, sometimes called a tax-sheltered annuity (TSA), is a tax-deferred retirement account for employees of public education institutions, nonprofits, and some religious organizations. Generally, 403(b)s are administered by large financial service firms like Vanguard or Fidelity.
A 403(b) plan is similar in some ways to a 401(k)s in that it offers the ability to defer some of your paycheck into an investment account to save for retirement.
No two 403(b) plans are the same as individual employers work with the plan providers to establish specific rules and offerings, including whether to offer matching funds, the ability to take loans against a balance, and the available investments.
"Employers typically contribute to these plans, generally, 1%-5% of compensation, much like their for-profit counterparts do," says Matthew Sanchez, a financial planner and private wealth advisor at Biechele Royce Advisors.
History and purpose of 403(b) plans
Congress first established 403(b) plans in 1958 as tax-sheltered annuities to help employees in the public education sector access retirement plan benefits. Employees in the public education sectors, including university employees, typically lacked access to pension plans and other retirement plan benefits.
Annuities were the only investment available in 403(b)s until 1974, when mutual funds also became accessible to plan participants.
"Historically, 403(b) plans' main investment options were annuities," explains Kenny Senour, a financial planner with Legacy Wealth Partners LLC. "That type of option comes with some ugly repercussions in the form of complexity, potential surrender charges, and opportunity cost in the form of meager returns versus a comparable mutual fund."
Key features of 403(b) plans
Eligibility requirements for 403(b) plans
To qualify for one of these specialized retirement accounts, you must meet the 403(b) plan eligibility requirements, which require you to work in one of the following sectors:
- Public primary, elementary, or secondary education
- Public colleges or universities
- Public schools run by American Indian tribal governments
- A 501(c)(3) tax-exempt organization
- Cooperative hospital organizations
- A church, synagogue, mosque, temple, or ministry
Contribution limits of a 403(b)
Like other retirement savings vehicles, the IRS limits how much you can contribute to a 403(b) plan each year. Generally, this limit increases by $500 each year to keep up with inflation. Here are the 403(b) contribution limits in 2024:
Employees under 50 can contribute up to $23,000, and employees 50 or older can contribute an additional catch-up contribution of $7,500.
You can contribute an additional $3,000 per year for at least five years if:
- You have been with the same organization for at least 15 years, and
- Your average annual contributions are less than $5,000 per year
That means if you're 50 or older and have had the same employer for 15 or more years, you can contribute up to $33,500 yearly for at least five years ($23,000 + $7,500 + $3,000 = $33,500).
Investment options for 403(b)s
Here are standard 403(b) investment options:
- Mutual funds
- Annuities
- A retirement income account (exclusive to church employees)
Retirement income accounts, or account-based pensions, are funds that offer regular income to employees after retirement. The assets within a retirement income account typically include stocks and bonds.
Plan sponsors determine the features and vesting schedules of their plans. Their employees often can self-direct their plan investments based on a menu of options.
Withdrawing from a 403(b)
Rules and regulations for 403(b) withdrawals
The date you can begin withdrawing money from your 403(b) plan may be determined by your provider. Though the IRS sets the minimum age for penalty-free withdrawal at 59½, your plan might have a different age written into the contract.
If you withdraw funds too early and don't qualify for an early withdrawal exception, you'll be charged a 10% penalty fee for the amount withdrawn. You can avoid the premature withdrawal penalty with a qualifying hardship exception, such as a permanent disability or financial hardship.
For example, if you're younger than your plan's minimum and want to take $10,000 out of your 403(b) account to pay for home repairs, you'd have to pay income tax on that amount — plus an extra $1,000 as a penalty ($10,000 x 0.10 = $1,000).
Qualified loans for 403(b)s
Your employer and plan provider may allow you to loan out a portion of your 403(b) account balance. Similar to a 401(k) loan, if you take that money from your plan as a loan, you won't have to pay taxes or penalties. However, you'd still have to pay the money back and may also have some interest applied.
Required minimum distributions (RMDs) for 403(b)s
Like most tax-deferred retirement plans, account holders of 403(b) must start taking required minimum distributions (RMDs) by age 73 or when they retire from their place of employment, whichever comes later.
RMDs from a 403(b) plan are calculated by dividing the account balance from the previous calendar year by a distribution period from the IRS's Uniform Lifetime Table. You can use IRS worksheets to help estimate how much that amount might be for you.
Benefits of a 403(b) plan
Tax advantages of a 403(b) plan
A 403(b) offers the benefit of tax-deferred growth, so you won't have to pay tax on the deferred funds, plus they earn until you withdraw during retirement. This is especially handy if you believe you will be in a lower tax bracket during retirement than your working years.
The initial tax break also lowers your taxable income while you are contributing to the plan.
Employer contributions for 403(b)s
Some 403(b) plans accept employer contributions. Like a 401(k) employer match, you can receive a matching contribution to your 403(b) account up to a certain percentage. This can increase retirement savings exponentially. However, employers aren't required to offer this benefit.
Employee and employer combined contributions can be up to $69,000 in 2024.
Potential drawbacks of a 403(b) plan
Limited investment choices
Compared to other retirement plans, the investment options for 403(b) plans are limited. Originally, annuities were the only investment option available with a 403(b), but now mutual funds are just as common. Still, the investment options made available to you are determined by your employer.
Church employees can invest in retirement income accounts, which contain a variety of assets like stocks and bonds.
Not subject to ERISA requirements
Since a 403(b) plan is often sponsored by a government entity or religious organization, it usually doesn't have to apply to the Employee Retirement Income Security Act (ERISA) of 1974 regulations. This means certain 403(b) plans do not have to adhere to the federal requirements regarding:
- Eligibility and participation
- Account reporting and disclosures
- Vesting
- Funding
- Accountability of plan fiduciaries
Non-ERISA 403(b)s have very little employer involvement. Employers cannot offer a third-party service provider or administrative support or implement discretionary decisions such as automatic enrollment or distribution eligibility.
Non-ERISA plans must still adhere to the rules and regulations established by the IRS.
Higher fees compared to other plans
Fees for a 403(b) are generally much higher than those of other retirement plans like 401(k)s. These high fees are partially due to the pricier assets in the account, such as annuities and mutual funds.
Another major factor is the lack of oversight, which causes participants to miss out on investment strategies that could minimize their fees. Since most 403(b)s are non-ERISA, plan providers are not required to oversee these accounts to the same degree as most other retirement plans.
ERISA protections also include maintaining fiduciary duty, another protection 403(b)s do not have. While this does not mean that plan providers are taking advantage of their plan participants, the lack of consumer protections leaves employees more vulnerable to potentially exuberant fees.
FAQs about 403(b) plans
Who is eligible for a 403(b) plan?
Employees eligible for a 403(b) plan are those who work for public schools, nonprofit organizations, and some religious organizations including certain ministers.
What are the contribution limits for a 403(b) plan?
The contribution limit for a 403(b) plan in 2024 is $23,000 per year for employees younger than 50. Employees aged 50 or older can contribute an additional catch-up contribution of $7,500 to their 403(b) plan.
How does a 403(b) differ from a 401(k)?
A 403(b) differs from a 401(k) in that it is designed for employees of nonprofit organizations, public education institutions, and certain religious organizations rather than for-profit businesses. However, when comparing a 403(b) vs a 401(k), you may find the investment options limiting and the account lacking standard regulations and consumer protections.
Can I roll over a 403(b) into an IRA?
You may be able to roll over a 403(b) into an IRA as long as your plan allows it. Most 403(b) plans are funded with pre-tax dollars, so rolling into a traditional IRA is simple. Certain employers may allow you to contribute after-tax dollars, in which rolling over assets into a Roth IRA would be best.
Are there penalties for early withdrawal from a 403(b) plan?
Like a 401(k), there are penalties for early withdrawal from a 403(b) plan without a qualifying hardship exception. A premature withdrawal from a 403(b) results in a 10% penalty fee on the amount withdrawn in addition to income tax.
