What Is a 403(b) Plan?

A 403(b) plan is a tax-advantaged retirement savings plan designed primarily for employees of public schools, nonprofit organizations, and certain religious institutions. It operates similarly to a 401(k) plan, allowing participants to contribute a portion of their salary on a pre-tax or Roth (after-tax) basis while benefiting from tax-deferred investment growth. These plans are commonly offered to teachers, school administrators, nurses, doctors working for nonprofit hospitals, and employees of 501(c)(3) organizations.

The Internal Revenue Service (IRS) regulates 403(b) plans, imposing contribution limits, withdrawal rules, and employer requirements. Contributions are typically made through payroll deductions, and participants can choose from a selection of investment options, most commonly mutual funds and annuity contracts.

How a 403(b) Plan Works

A 403(b) plan allows employees to contribute a percentage of their salary toward retirement, often with matching contributions from their employer. These contributions can be either traditional (pre-tax) or Roth (after-tax):

• Traditional 403(b): Contributions are made before taxes, reducing taxable income in the year of contribution. Taxes are deferred until withdrawals begin in retirement.
• Roth 403(b): Contributions are made after taxes, meaning withdrawals in retirement (including earnings) are tax-free, provided certain conditions are met.

Employers offering a 403(b) plan may also contribute to employees' accounts, either through matching contributions (up to a certain percentage) or nonelective contributions, where they deposit funds regardless of employee participation. Employer contributions, however, may be subject to vesting schedules, which dictate how long an employee must remain with the organization before they gain full ownership of the funds.

Contribution Limits and Catch-Up Provisions

The IRS sets annual contribution limits for 403(b) plans, which change periodically based on inflation adjustments. As of 2025, the standard employee contribution limit is $23,500 per year, with an additional $7,500 catch-up contribution allowed for individuals age 50 and older.

One unique feature of the 403(b) plan is the 15-year rule, which allows employees who have at least 15 years of service with the same employer to contribute an additional $3,000 per year, up to a lifetime maximum of $15,000. This provision benefits long-term employees of schools, hospitals, and charities who may have fallen behind on retirement savings.

Investment Options and Annuities

403(b) plans historically focused on annuity contracts sold by insurance companies, which is why they are sometimes referred to as tax-sheltered annuities (TSAs). While annuities remain an option, most modern 403(b) plans include mutual funds, which provide greater diversification and growth potential.

Plan participants can typically invest in:

• Fixed Annuities: Provide a guaranteed interest rate and stable returns, with lower risk.
• Variable Annuities: Allow investment in subaccounts similar to mutual funds, offering potential for higher returns but also carrying more risk.
• Mutual Funds: Offer a diversified portfolio of stocks, bonds, and other assets, which can be managed actively or passively.

Unlike 401(k) plans, which often include low-cost mutual funds and ETFs, 403(b) plans sometimes have higher fees, especially when they include annuity-based products. It’s important for participants to compare costs and investment choices before deciding how to allocate contributions.

Withdrawal Rules and Required Minimum Distributions (RMDs)

Withdrawals from a traditional 403(b) plan are taxed as ordinary income and may be subject to a 10% early withdrawal penalty if taken before age 59½, unless an IRS-approved exception applies. Some exceptions include:

• Separation from service after age 55
• Permanent disability
• Certain medical expenses exceeding 7.5% of adjusted gross income (AGI)
• Substantially equal periodic payments (SEPP)

Roth 403(b) withdrawals are tax-free if the account has been held for at least five years and the participant is 59½ or older.

Once a participant reaches age 73 (as of 2023 under SECURE Act 2.0), required minimum distributions (RMDs) must begin, ensuring that retirees withdraw a portion of their savings each year. However, Roth 403(b) accounts will not be subject to RMDs beginning in 2024, allowing funds to continue growing tax-free indefinitely.

403(b) vs. 401(k) Plans

While 403(b) and 401(k) plans share many similarities, they have key differences:

• Eligibility: 403(b) plans are limited to public schools, nonprofits, and religious institutions, whereas 401(k) plans are available to private-sector businesses.
• Investment Choices: 403(b) plans often include annuities, whereas 401(k) plans offer a broader range of mutual funds and other securities.
• ERISA Status: Many 403(b) plans, especially those without employer contributions, are exempt from the Employee Retirement Income Security Act (ERISA), meaning they have fewer regulatory requirements than 401(k) plans.

Pros and Cons of a 403(b) Plan

Advantages

• Tax Advantages: Contributions reduce taxable income (traditional 403(b)) or grow tax-free (Roth 403(b)).
• Catch-Up Contributions: The 15-year rule provides additional savings opportunities for long-tenured employees.
• Potential Employer Contributions: Some employers match a percentage of employee contributions.
• Lower Administrative Costs: Non-ERISA 403(b) plans may have fewer compliance costs.

Disadvantages

• Limited Investment Choices: Some 403(b) plans offer only annuities, which may have high fees and surrender charges.
• Early Withdrawal Penalties: Withdrawals before 59½ may trigger taxes and penalties.
• Potential for High Fees: Insurance-based investment options in some 403(b) plans can carry higher costs than mutual funds in a 401(k).

The Bottom Line

A 403(b) plan is a valuable retirement savings vehicle for employees of public schools, nonprofits, and religious organizations. It provides tax-deferred growth, employer matching opportunities, and unique catch-up provisions for long-term employees. However, plan participants should carefully review investment options, fees, and withdrawal rules to make informed decisions. Understanding the nuances of a 403(b) can help employees maximize their retirement savings and secure financial stability in their later years.