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- A 403(b) plan is a retirement plan for employees of public schools, nonprofits, and religious organizations.
- A 403(b) plan is a tax-deferred retirement plan that invests your money in annuities and mutual funds.
- Employers determine how their 403(b) plans are structured and what options employees have to choose from.
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It can take a lifetime to save up enough money to retire. That's why it's important to know what your employer-sponsored retirement options are as soon as possible. You may be familiar with 401(k) plans. But if you work in public education or for a nonprofit, cooperative hospital, or religious organization, you likely will have a different retirement option: the 403(b) plan.
What is a 403(b) plan?
A 403(b) plan is a tax-deferred retirement account that's generally for employees of public education institutions, nonprofits, and some religious organizations. The employer must meet IRS eligibility standards to offer a 403(b) plan to its employees.
You may be able to contribute a portion of your pre-tax earnings to a 403(b) plan if you 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
Understanding how 403(b) plans work
403(b) plans are very similar to 401(k) plans (the numerical names refer to which part of the tax code each complies). They allow you to contribute a certain amount of your pre-tax income to a retirement fund, where it can grow tax-free until you begin to take distributions. These plans also allow employers to make contributions.
"Employees can make contributions [to a 403(b)] in 2021 up to $19,500," says Matthew Sanchez, a Certified Financial Planner and wealth advisor at Biechele Royce Advisors. "For employees aged 50-plus, they can contribute an additional $6,500, for a total of $26,000. Employers typically contribute to these plans, generally 1%-5% of compensation, much like their for-profit counterparts do."
No two 403(b) plans are the same. Individual employers work with companies that provide and manage 403(b) plans to determine what they want to offer employees in their company-sponsored plan. Options could include offering matching funds, the ability to take loans against a balance, and choices about how employees' money is invested.
At the very least, you should be allowed to make elective deferrals, which is choosing how much of your pay goes into your retirement account. Your employer may choose whether to make its own contributions to your fund. They aren't required to, though many do as an added benefit of employment. For 2021, combined contributions to a 403(b) plan tops out at $58,000.
Employers also determine what kinds of investment choices you have as a 403(b) plan participant. Kenny Senour, Certified Financial Planner with Millennial Wealth Management, says that plan sponsors are the ones who determine what features their plans will have and what kind of vesting schedule they will offer. Their employees often have the ability to self direct their plan investments based on a menu of options provided to them.
"Historically, 403(b) plans' main investment options were annuities," he adds. "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 … Fortunately, for the sake of simplicity and transparency, many of these plans have moved toward a more 'open architecture' structure, where participants have access to a streamlined investment menu of lower cost mutual funds."
Rules regarding withdrawals from 403(b) plans are similar to what you find with 401(k) plans. Money cannot be withdrawn before age 59.5 without penalty unless you:
- Are no longer employed with the sponsor of the plan
- Are disabled
- Have died
- Have a financial hardship
- Have a qualified reservist, birth, or adoption distribution
- Have certain distributions of lifetime income investments
Your individual plan may allow you to take a loan against the money in your 403(b) or apply for early withdrawal under the circumstances above without penalty. Early withdrawals that don't meet the exceptions above may be subject to a penalty equal to 10% of the amount taken out.
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). If you took that money from your plan as a loan, you wouldn't have to pay taxes or penalties on it. However, you'd have to pay the money back and may have some interest applied, as well.
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 59.5, your plan might have a different age written into the contract. If you haven't already started taking withdrawals from your 403(b) plan by the time you're age 72, you are required to start at that time.
"The types of withdrawals available to employees in retirement are plan specific," Senour says. "But, typically, employees have the option to rollover their account to another qualified retirement account, take a lump sum distribution, or set up 'installment payments' on a monthly or quarterly basis."
Any withdrawal is considered taxable income for the year in which it is received, except for money that was originally contributed to the account after taxes were paid. According to the IRS, if you don't take at least the minimum amount required from your account, "you are subject to a nondeductible 50 percent excise tax on the difference between the required minimum distribution and the amount actually distributed."
Pros and cons of a 403(b) plan
Like any financial product, 403(b) retirement plans have their benefits and challenges. They provide an easy way to save for retirement today while lowering your immediate tax liability. But you have to wait until you reach a certain age before you can use the money you've saved and will have to pay taxes on it then. Here is a look at some of the other pros and cons of 403(b) plans.
| Pros | Cons |
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403(b) vs. 401(k)
The 401(k) is the retirement fund option most private employers offer and is often more recognized than the 403(b). They are very similar in many ways, but there are some important differences you'll want to know about. Here is a look at both.
| 403(b) | 401(k) | |
| Individual contribution limits | $19,500 for elective deferrals and $6,500 for catch-up contributions in 2021. Employees with least 15 years of service with the same employer can add $3,000 above limits for catch-up contributions for up to 5 years. | $19,500 for elective deferrals and $6,500 for catch-up contributions in 2021 |
| Employer matching | Up to 25% of eligible payroll | Up to 25% of eligible payroll |
| Investment decisions | Only annuities and mutual funds | Any investment allowed by the plan provider |
The financial takeaway
The 403(b) is the standard for employer-sponsored retirement savings in the nonprofit and public education sector. If you work in any of these eligible industries and want to plan for retirement, you'll want to speak with your employer about what 403(b) options are offered. They are the ones who determine the details of what's available to you through a company 403(b) plan, what rules apply, and when you can participate.
Once you have that information, consult with a financial advisor to determine how you can best use the plan to achieve your retirement goals.