403(b) Plans: What You Need to Know

If you work for a nonprofit, such as a governmental organization, charitable organization, or school district, you might have a 403(b) plan instead of a 401(k). What is a 403(b) plan? And are you missing out by not having a 401(k)?

Learn how a 403(b) works and its pros and cons so you can make an informed choice about your retirement planning.

What is a 403(b)?

A 403(b) plan is a defined contribution retirement savings plan offered by many schools and other nonprofit organizations. A defined contribution retirement plan is one where you contribute a portion of your pay to the plan to build a retirement fund.

A 403(b) is similar to a 401(k) plan in many respects. For example, if you’re an employee of an organization that sponsors a 403(b), your contributions can be deducted directly from your pay. These contributions are made pre-tax, and you pay taxes at your ordinary income tax rate when you withdraw the funds later on. Your contributions lower your taxable income. 403(b) plans are also known as tax-sheltered annuities or TSA plans.

A 403(b) usually offers a menu of mutual funds or other investment options similar to what you might see in a 401(k) plan. The investment menus of 403(b) plans are usually narrower than with a typical 401(k) plan, however. A 403(b) plan could be a key tool in saving for retirement. Sponsoring organizations can offer both a traditional 403(b) and Roth 403(b) if they choose.

What is a Roth 403(b)?

Similar to a Roth 401(k), a Roth 403(b) option allows employees to make contributions on an after-tax basis. The money in a Roth 403(b) plan could then be withdrawn tax-free and penalty-free if certain requirements, such as reaching age 59 1/2 and satisfying the five-year rule, are met. The five-year rule is that it has to be five years since your first contribution to a Roth 403(b) before you can make a penalty-free withdrawal.

A Roth 403(b) differs from a traditional 403(b) where contributions are generally made on a pre-tax basis, with distributions taxed as ordinary income. Also, as with a Roth 401(k), any matching contributions from the employer are deposited into a traditional 403(b) account per the rules governing these plans.

Balances in a Roth 403(b) would be subject to required minimum distributions, the same as with a Roth 401(k). A required minimum distribution, or RMD, is a set minimum amount you’re required to withdraw from certain retirement accounts starting at age 72. To avoid an RMD on a Roth 403(b), consider rolling your Roth 403(b) balance over to a Roth IRA.

How does a 403(b) work?

403(b) plans are funded by employee contributions. The IRS sets annual contribution limits for 403(b)s, which are the same as for a 401(k) plan. For 2024, the total contribution limits are $23,000 plus a $7,500 catch-up contribution for those who are age 50 or older. If an employee has worked for their organization for at least 15 years, or they meet other requirements, they may be eligible to contribute an additional $3,000 annually for up to five years.

Some 403(b) sponsors may choose to make matching contributions, but this will vary from organization to organization.

Vesting is another important consideration when it comes to retirement plans like 403(b)s. Vesting refers to your ability to take any employer contributions made to the plan on your behalf when you leave your employer. For example, your employer might require you to be employed for one year before your employer’s 403(b) contributions are vested. If you leave that employer before you’re vested, you’ll only be able to roll over your contributions to another account like an IRA or a new employer’s 403(b). You won’t be able to take any employer contributions.

Vesting periods for 403(b) plans are sometimes shorter than vesting periods for a 401(k) plan, but again, this will vary from plan to plan.

You can also designate one or more beneficiaries who would receive your account benefits if you die

How do you withdraw funds from a 403(b)?

Withdrawals from the 403(b) plan would be made by contacting the plan administrator or the human resources department of the employer offering the plan. Each plan will have its own process for completing paperwork for the withdrawal, and many will offer the ability to do this online as well.

For a traditional 403(b), there is generally an early withdrawal tax penalty for withdrawals made prior to age 59 1/2. There are some exceptions to this, such as the need to cover a large medical expense. It is best to contact the plan administrator to see exactly what qualifies as an exception. Distributions from a traditional 403(b) are fully taxable.

Withdrawals from a Roth 403(b) are generally tax-free if you’ve satisfied the five-year rule and are at least age 59 1/2. There are exceptions to the early withdrawal penalty under certain circumstances.

When leaving your employer, you can generally roll the balance in your account over to an individual retirement account, or in some cases, to a retirement plan with a new employer. Rolling the balance over keeps the tax-advantaged nature of the account intact and allows you to defer any taxes that would be due if you withdrew money from the plan.

Pros and cons of a 403(b)

Pros	Cons
Tax advantages	Fewer investment options
High annual contribution limits	Higher fees
Shorter vesting schedules	Not always covered by ERISA
Extra catch-up contributions

Pros

• A 403(b) plan offers several tax advantages. First, a traditional 403(b) option offers the ability to make pre-tax contributions, which provides an immediate tax break in the year the contributions are made. Money contributed to a traditional 403(b) account grows tax-deferred until withdrawn. Plans that offer a Roth option provide a different type of tax advantage. Although Roth contributions are made with after-tax dollars, the contributions grow tax-free. Withdrawals are tax-free if made after you reach age 59 1/2 and if certain other requirements are met.
• As with 401(k) plans, 403(b) plans offer higher contribution rates than many other types of retirement plans. For 2024, the contribution limit is $23,000, with an additional $7,500 contribution limit for those who are age 50 or older.
• There are different types of vesting and vesting schedules vary from plan to plan, but generally, 403(b) plans often have shorter vesting schedules than 401(k) plans.
• Long-tenured employees covered by a 403(b) plan have the ability to make additional catch-up contributions. If their plan allows for it, they could contribute an extra $3,000 annually over and above the normal contribution limits, including the regular catch-up contributions. The “15-year rule” allows employees who have been with the employer offering the plan for at least 15 years to contribute $3,000 annually over a five-year period.

Cons

• 403(b) plans tend to offer more limited investment menus than 401(k) plans and certainly more limited than IRAs.
• Due to the investments sometimes offered in a 403(b), in many cases the underlying fees and expenses are higher than with a 401(k) or other types of plans. This is especially true with 403(b) plans that primarily offer annuities and insurance-based investment choices that tend to be more expensive than investment options, such as mutual funds.
• Some 403(b) plans are not covered by the Department of Labor’s Employee Retirement Income Security Act rules and fiduciary standards. 401(k) plans are covered by ERISA rules. The disadvantage here is that plans covered by ERISA must abide by rules put in place by the Department of Labor that offer a level of protection to plan participants. Non-ERISA 403(b) plans are not obligated to abide by these rules.

FAQs

Bottom line

If you work for an employer who offers a 403(b), review the plan carefully regarding the investments offered, the plan expenses, and other factors involved with the plan. Even if the plan has some shortcomings, it still might be a good idea to contribute at least some money, especially if your employer offers a matching contribution. Check out this article to learn more about the pros and cons of 403(b) plans.