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A 403(b) plan, also known as a tax-sheltered annuity plan, is a retirement account available to certain employees, including public school teachers and nonprofit workers. A 403(b) plan functions similarly to a 401(k) plan by featuring tax-deferred growth and high annual contribution limits.

What Is a 403(b) Plan and How Does It Work?

A 403(b) plan is a tax-deferred retirement plan specifically for employees of public schools, certain nonprofit organizations and churches. They share many similarities with 401(k) plans.

It’s estimated that about one in five U.S. employees had access to these accounts in 2018, according to Investment Company Institute.

A 403(b) plan is offered by employers to their employees. You can contribute part of your salary to the account, and your employer may also make contributions.

You can also choose how the money is invested inside your 403(b) account. According to a report by the Investment Company Institute, 403(b) plan participants had about 40 investment options to choose from, on average, in 2017.

Investment choices most often include mutual funds and annuities.

Key Facts About 403(b) Plans
  • Money grows in your account free of capital gains taxes.
  • Yearly contribution limits are $19,500 in 2021. Employees ages 50 and older can contribute an extra $6,500.
  • Employees who have worked for the same organization for at least 15 years can contribute an additional $3,000 a year, regardless of age.
  • You can begin making tax-free withdrawals at age 59.5.
  • You must begin taking required minimum distributions by age 72.

A 403(b) plan provides several tax advantaged ways to save for retirement.

First, money is deducted from your paycheck tax-free and grows tax-deferred within your retirement account. You are sparred paying capital gains tax while your money grows, and contributions also lower your yearly tax bill.

There is a catch, of course. When you take money out in retirement, you must pay income tax on withdrawals.

In 2021, you can contribute up to $19,500 a year to a 403(b) plan. Employees ages 50 and older can contribute an extra $6,500.

You can start making tax-free withdrawals from a 403(b) at age 59.5. If you withdraw funds before this age, you’ll face a 10 percent penalty from the IRS, unless you have a qualifying life event, such as a disability or medical emergency.

The IRS requires you to start making withdrawals, known as required minimum distributions, at age 72.

Who Is Eligible for a 403(b) Plan?

Not everyone can sign up for a 403(b) plan. For tax reasons, only employees of certain organizations and institutions are eligible to participate.

The following people are eligible to participate in a 403(b) plan:
  • Employees of tax-exempt 501(c)(3) organizations
  • Employees of cooperative hospital service organizations
  • Public school employees who are involved in the daily operations of a school
  • Civilian faculty and staff of the Uniformed Services University of the Health Sciences
  • Ministers employed by a 501(c)(3) organization
  • Self-employed ministers
  • Ministers or chaplains who are employed by a non-501(c)(3) organization but who function as ministers in their daily professional responsibilities with their employers

According to the IRS, employers can choose to exclude employees who typically work less than 20 hours per week from participating in a 403(b) plan.

Advantages and Disadvantages of 403(b) Plans

Advantages of 403(b) Plans
  • Save for retirement tax-deferred.
  • Enroll at work and your employer handles most of the paperwork
  • Take advantage of high annual contribution limits
  • Contributions lower your annual taxable income for that year
  • 403(b) plans come with an extra catch-up contribution of $3,000 if you’ve worked at the same organization for 15 years or more

However, these accounts come with a few drawbacks.

Depending on your investing experience, the selection of investment options may be an advantage or a disadvantage. If you want more options, consider opening a separate individual retirement account (IRA) at a brokerage company.

Disadvantages of 403(b) Plans
  • Ten percent additional IRS tax if you withdraw funds prior to age 59.5.
  • Typically comes with higher fees than other retirement plans
  • Fewer employers offer contribution matches for 403(b) plans than 401(k) plans

Make sure to carefully evaluate the annual fees and costs associated with a 403(b) plan before signing up.

403(b) Plans Versus 401(k) Plans

A 403(b) plan is very similar to a 401(k) plan. Both are offered by employers, and both accounts allow your employer to make contributions to your account.

The biggest difference between the two is 401(k) plans are offered by for-profit companies whereas 403(b) plans are offered by certain government, nonprofit and religious organizations.

Another difference is 403(b) plans allow employees with at least 15 years of service with the same nonprofit or government agency to contribute an additional $3,000 a year to their account. There is a $15,000 lifetime limit for this additional contribution.

Finally, 403(b) plans tend to be administered by insurance companies, while most 401(k) plans are administered by mutual fund companies.

This may explain why 403(b) plans more often feature annuities — which are insurance products — than 401(k) plans.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: September 16, 2021

6 Cited Research Articles

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  1. Internal Revenue Service. (2021, March 4). Choosing a Retirement Plan: 403(b) Tax-Sheltered Annuity Plan. Retrieved from https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-403b-tax-sheltered-annuity-plan
  2. Internal Revenue Service. (2021, August 19). Retirement Plans FAQs regarding 403(b) Tax-Sheltered Annuity Plans. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-403b-tax-sheltered-annuity-plans
  3. Marquit, M. and Curry, B. (2021, February 9). Retirement Basics: What Is A 403(b)? Retrieved from https://www.forbes.com/advisor/retirement/403b-plan/
  4. Mercado, D. (2018, September 29). Why these teachers’ retirement plans aren’t making the grade. Retrieved from https://www.cnbc.com/2018/09/28/why-these-teachers-retirement-plans-arent-making-the-grade.html
  5. Moore, J. (2021, January 22). 403(b) Plan Investment Lineups Have Changed. Retrieved from https://www.plansponsor.com/403b-plan-investment-lineups-changed/
  6. U.S. Securities and Exchange Commission. (2017, July 20). Investor Bulletin: Retirement Investing Through 403(b) and 457(b) Plans. Retrieved from https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_retirementinvesting