What Is a 403(b) Plan?

Definition and Examples of a 403(b) Plan

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A 403(b) plan is a tax-sheltered annuity (TSA) plan offered to employees of tax-exempt organizations such as nonprofits, churches, hospitals, and public education institutions. Employers might offer these retirement savings plans as part of an employee's benefits package, and they can actually benefit both parties.

A 403(b) plan offers two ways to invest the funds within the account.

What Is a 403(b) Plan?

Employees can have their employers defer portions of their pay to these retirement accounts so that these earnings aren't subject to income tax until the money is later withdrawn. Employers can match employees' contributions.

Eligible employers that can offer 403(b) plans to their employees include public schools or universities, churches, and 501(c)(3) charitable organizations.

  • Acronym: TSA plan

How Does a 403(b) Plan Work?

Just as with a 401(k) plan, you have the option to invest your money in conservative, middle, or high-risk investments when you defer your earnings to a 403(b) plan.

You can balance your 403(b) portfolio between riskier and safer investments by talking to a human resources representative at your company. You might also seek the advice of a financial advisor.

You can take the money with you if you change jobs after you're vested in the plan, but you might have to roll it over into an IRA account. You'll lose your employer’s contributions if you're not vested, but you'll keep the money that you've personally put into your plan.

You own your 403(b) plan when you're "vested" in it. The percentage that you're vested increases with each additional year of employment. Your employer can't take back any contributions they made after you're 100% vested.

Some employers will require that you roll the account over, while others will allow you to stay with your current plan as long as you have a specific amount in the account. Your human resources representative should be able to answer your questions or connect you with someone who can.

403(b) Plans vs. 401(k) Plans

These TSA plans are similar to 401(k) plans, but there are some differences.

403(b) Plans 401(k) Plans
These plans are offered by tax-exempt organizations. These plans are offered by for-profit companies.
Employers can and usually do match an employee's contributions. Employers can only match an employees contributions subject to ERISA rules.
Investment options are limited to annuities and mutual funds. Investment options include annuities, mutual funds, stocks, and bonds.

Pros and Cons of 403(b) Plans

Benefits of a 403(b) plan for an employer include the ability to attract and retain employees by offering matching benefits. A company might offer to match employee contributions to their 403(b) plan dollar-for-dollar on the first 5% of payroll.

Benefits for employees include:

  • Pre-tax contributions to a 403(b) plan and earnings on these amounts are not taxed until they're distributed from the plan.
  • Money in a 403(b) can grow tax-deferred for decades, resulting in far more wealth for the owner of the account. They'll only pay taxes on the funds when they begin to take withdrawals from their 403(b) accounts.
  • You might be eligible to take a tax credit for elective deferrals contributed to your 403(b) account.
  • Account-holders can take loans against their 403(b) plans if they're in need of cash in an emergency. But these 403(b) loans must be paid back, just like their 401(k) counterparts, or there will be significant tax consequences.

Requirements for 403(b) Plans

The government provides fairly high 403(b) contribution limits for those who want to plan for retirement. The maximum potential 403(b) contribution is $58,000 per year as of 2021 if you meet certain conditions.

Contributions that can be made include:

  • Basic salary deferral (the maximum payroll amount an employee can contribute to their 403(b) plan by having money taken out of their check) is $19,500 as of 2021.
  • Employees 50 years and older can add $6,500 per year in special 403(b) contributions called “catch-up” 403(b) contributions. This is in addition to the $19,500 that all employees can put aside.
  • Some people are eligible for an additional 403(b) contribution known as the "special section 403(b) catch-up" or the "years of service catch-up." This special type of 403(b) contribution is only available to employees who have worked for a qualified organization for 15 years or longer. This special 403(b) contribution is referred to as the “15-year rule” in IRS Publication 571.

The government allows 403(b) contribution limits to increase for inflation by releasing the cost of living adjustment figures each year.

How Much Should You Contribute to a 403(b)?

The average goal for most people is to save around 15% of their incomes for retirement each year. Your employer match also counts toward that total.

You should always take full advantage of your employer match if you have one because it's basically free money, earmarked for your retirement.

Consider investing in your 403(b) plan up to the full amount that your employer matches. You might increase the amount of your contributions each time you get a raise, then max out your IRA contributions. Then you can return to your 403(b) until you've reached the 15% goal if you still have funds you'd like to invest in your retirement.

Key Takeaways

  • A 403(b) plan is a tax-sheltered annuity plan offered by non-profit and tax-exempt employers rather than for-profit companies.
  • Contributions you make to a 403(b) plan aren’t taxed until you withdraw the money, and your investment grows tax-deferred.
  • These plans are similar to 401(k) plans but investments are limited to annuities and mutual funds.
  • There are contribution limits, but they're fairly generous and they inch upward each year to keep pace with inflation.