A 403(b) plan is a type of retirement savings plan that is similar to a 401(k) plan but with a few differences.

This type of retirement plan is available for teachers and those working in tax-exempt charitable organizations. Here’s an overview of how a 403(b) plan works, pros and cons, contribution limits, and eligibility requirements.

What Is a 403(b) plan?

A 403(b) plan is a retirement plan for employees in public schools, 501(c)(3) tax-exempt organizations, and some faith-based organizations. Employers offer this type of retirement plan to attract workers.

How Do 403(b) Plans Work?

With a 403(b) plan, you can set aside money from each paycheck for retirement. The money you save, as well as any employer contribution, can be invested in annuities, mutual funds, and other assets.

One of the main benefits of the 403(b) plan is the tax benefit it offers. You can contribute pre-tax dollars to your account, which can lower your tax liability and may offer you a larger tax refund. Your investments can continue to grow tax-deferred until you start withdrawing in retirement.

Some employers may also offer Roth 403(b) plans where you contribute after-tax dollars. This means that you won’t have to pay any income tax when you withdraw the funds or investment earnings.

Eligibility Criteria for a 403(b) Plan

You may be eligible for a 403(b) plan if you’re:

  • An employee of a public school and are involved in its day-to-day operations
  • An employee in a 501(c)(3) organization
  • A minister employed by a 501(c)(3) organization, employed by another organization and working as a minister in your day-to-day responsibilities, or self-employed
  • An employee of a cooperative hospital organization

Employers that offer 403(b) plans must offer them to all employees as per the “universal availability rule.” However, some employees may be excluded from the plan:

  • Nonresident aliens
  • Employees that participate in another 403(b), 457(b), or 401(k) plan with the same employer
  • Employees working less than 20 hours/week
  • Students who are enrolled in and regularly attend classes at an institution and work for the school or a non-profit organization operated for the school

“ If you work for a non-profit and they offer a 403 (b) plan, this could help you save on taxes,” shares Teresa Dodson, founder of Greenbacks Consulting. 

Contribution Limits and Rules for a 403(b) Plan

Like 401(k) contribution limits, there are specific rules and contribution limits for 403(b) plans. For 2024, the total contribution limit is $23,000 for employee contributions. If you’re aged 50 or older, you can contribute an additional $7,500 as a catch-up provision.

The catch-up contribution limits for employees with 15 years of service are the lesser of:

  • $3,000; or
  • $5,000 times the number of years of service, minus elective deferrals made in the previous years; or
  • $15,000, minus the number of additional elective deferrals made in the previous years.

In addition to your contributions, your employer can also contribute to your plan. In most cases, employers make a matching contribution up to a percentage of your salary.

Withdrawal and Distribution Rules for a 403(b) Plan

403(b) plans are designed to help you save for retirement, so there are strict rules for when and how you can withdraw from the plan.

403(b) Plan Withdrawal Rules

You can make penalty-free withdrawals from the plan once you reach 59 ½ age. However, if you have a traditional 403(b) and make pre-tax contributions, you’ll still need to pay taxes on withdrawals.

If you withdraw before you reach age 59 ½, you’ll have to pay applicable taxes and a 10% early-withdrawal penalty. Like 401(k) loans, your plan may allow you to take out a loan from your 403(b) plan and avoid the early withdrawal penalty. However, you’ll still need to pay the loan back with interest.

Withdrawing from the plan means you’ll miss out on compound returns, and you’ll have to repay the money before you file taxes if you leave your job.

Required Minimum Distributions (RMDs) From a 403(b) Plan

Like other retirement accounts, you’ll eventually need to make withdrawals from your 403(b) plan. Normally, you’ll need to start withdrawing when you turn 73, but some plans have an extension to age 75. If you’re still working at the organization where you have the plan, you can delay withdrawing until you retire.

Required minimum distributions (RMDs) are determined based on your IRS-calculated life expectancy and account balance. If you don’t withdraw the required amount each year, you may have to pay 25% of the amount in penalties along with potential taxes.

Benefits of a 403(b) Plan

If you’re eligible, there are many benefits of contributing to a 403(b) plan:

  • The contribution limits for 403(b) plans are much higher than IRA accounts and on par with 401(k) plans.
  • You can get a smaller tax bill when you contribute to the plan or enjoy tax-free withdrawals in retirement, depending on whether you opt for a traditional or Roth 403(b) plan.
  • Employers may match your contribution up to a percentage of your salary.
  • Many 403(b) plans have shorter vesting schedules compared to 401(k) plans.
  • You’ll be able to make extra catch-up contributions if you’ve worked with your organization for at least 15 years.

Drawbacks of a 403(b) Plan

While there are many benefits, there are also a few drawbacks of a 403(b) plan that you should be aware of:

  • 403(b) plans may have fewer investment choices compared to an IRA or 401(k).
  • Some plans may have higher fees that can lower your profits.
  • You’ll have to pay a penalty if you withdraw funds early.

Differences Between a 403(b) Plan and 401(k) Plan

403(b) plans are for employees of charities and public organizations, while 401(k) plans are for private company employees. Both are tax-advantaged accounts that allow you to save for retirement.

Compared to 403(b) plans, 401(k) plans usually offer employer matching at a higher rate. However, plan participants who have worked with the organization for over 15 years can make additional catch-up contributions to your 403(b) plan.

403(b) plans also have limited investment options and mostly feature annuities, but 401(k) plans have a variety of investment options, such as mutual funds.

A 403(b) Plan Can Help You Save for Retirement

If you’re an employee of a public school or public organization, your employer may offer you a 403(b) plan. Contributing to a retirement savings account, whether it’s a 403(b) or 401(k) plan, can allow you to enjoy financial freedom in retirement.

To maximize your retirement savings, you should start making contributions from an early age, ideally when you begin your career. We recommend investing 15% of your income in the account each year. If not, you should at least try to invest enough to take full advantage of the employer match.

While you focus on retirement savings, don’t forget to focus on other money management areas, such as building an emergency fund and paying off debt.

Furthermore, if you’re self-employed or run a small business, consider a tax-advantaged retirement plan like SEP IRA, which provides a flexible way to save for retirement while benefiting from tax advantages.