A 403(b) is a tax-advantaged retirement plan designed for non-profit organizations and certain government entities. The 403(b) works a lot like its better-known counterpart, the 401(k), although it offers a few unparalleled benefits like enhanced catch-up contributions for tenured employees. If you’re saving for retirement with a 403(b) account, here’s what you need to know.
What Is a 403(b) Plan?
A 403(b) is a tax-advantaged retirement plan for employees of non-profit organizations, like churches and hospitals, as well as some public-sector workers such as teachers and librarians.
As with all employer-sponsored retirement plans, 403(b)s offer tax-efficient growth for your retirement savings. This means the investments you buy and sell in your account are free of capital gains taxes, which helps you build your nest egg for retirement.
The contributions you make to a 403(b) account are deducted from your paycheck. With a traditional 403(b), contributions are deducted from your pay before taxes, which lowers your overall tax bill today. When you take out money from your account in retirement, you owe income taxes on the withdrawals.
If your employer offers the option of a Roth 403(b), you can choose to fund your account with money that’s already been taxed. You won’t pay any taxes when you withdraw money from the account later—even on investment earnings, no matter how much your money has earned.
403(b) Contribution Limits
For 2023, the 403(b) employee contribution limit is $22,500. Employees who are 50 or older can make additional catch-up contributions of $7,500, bringing their total contribution limit in 2023 to $30,000.
The 2024 employee contribution limit is $23,000. With a catch-up contribution—an extra allowance of up to $7,500—the 2024 total ceiling on contributions by workers age 50 and older is $30,500.
A notable benefit of the 403(b) is that employees who have worked with the same eligible organization for at least 15 years are permitted to make bonus catch-up contributions of $3,000 a year—up to a lifetime total of $15,000. These do not replace the federal catch-up contribution for those 50 and older, meaning if you were 50 or older, you could hypothetically contribute $33,000 a year for five years.
Though it’s much less common than with the 401(k), employers may also fund their employees’ 403(b) accounts with matching or non-matching contributions. For 2023, combined employee and employer contributions can be up to $66,000 or 100% of your most recent yearly salary, whichever is less. For 2024, the dollar portion of that formula is $69,000.
How to Invest in a 403(b)
Investment options available in 403(b) plans are somewhat more limited than other tax-advantaged retirement plans. You generally can choose from mutual funds and annuities. Unlike 401(k)s, you typically cannot invest individual stocks, exchange-traded funds (ETFs), or real estate investment trusts (REITs).
That said, many 403(b)s will offer you the low-cost bond and stock index funds most experts recommend for investing for retirement. You’ll want to pick a ratio of stock funds to bond funds that reflects the amount of time you have before retirement as well as your willingness to take on risk. This usually means more stock funds when you’re young and increasingly more bond funds as you age.
If your 403(b) plan offers target-date funds, they can greatly simplify your investment strategy. Target-date funds are mutual funds that automatically adjust their holdings to support you as you near your target retirement date.
You may also choose to invest part or all of your retirement savings in an annuity through your 403(b). Annuities can be complex financial instruments with high fees and lower-than-market returns, so check with a financial advisor before entering into one.
If your 403(b) plan doesn’t offer the choices you want, you can also use an individual retirement account (IRA) to supplement your portfolio. If your employer has a 403(b) match, however, make sure you’re contributing enough to get that before investing in an IRA.
403(b) Withdrawals
Standard 403 (b) Withdrawals
Standard 403(b) withdrawals are ones made after you turn 59 ½ and in certain other cases. If you have a traditional 403(b) account, standard withdrawals are taxed as regular income. Withdrawals from a Roth 403(b) account are tax-free.
You qualify for a standard withdrawal when you:
- Reach age 59 ½
- Become disabled
- Experience financial hardship
- Die (your beneficiaries can take withdrawals from your account)
Note: Once you turn 72 the IRS mandates certain minimal withdrawals called required minimum distributions (RMDs). If you aren’t already withdrawing the minimum amount to finance your retirement, you must start then or you could face a tax penalty equal to half of your RMD.
The starting age for RMDs is 73 if you reach age 72 after December 31, 2022.
Early 403(b) Withdrawals
Withdrawals from your 403(b) account that are made before you reach age 59 ½ are subject to a 10% penalty on top of taxes on any money that hasn’t been taxed before. There are a few exceptions that let you skip the early withdrawal penalties, including:
• The Rule of 55. If you part ways with your employer at age 55 or later, you can start taking withdrawals from that employer’s 403(b) penalty-free. This only applies to money held in that 403(b); any money in IRAs or prior employer retirement accounts will be penalized as normal.
• Substantially equal periodic payments (SEPPs). Through a rule known as 72(t), you can agree to stick to a payment schedule and avoid the 10% penalty for early withdrawals at any age. However, you have to take these distributions for at least five years or until you turn 59 ½, whichever comes later. Talk to a financial advisor for help calculating your SEPP withdrawals.
• Medical emergency. If you have unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, you can take an early withdrawal to cover those without paying the penalty.
Before you take a 403(b) early withdrawal, review your situation and determine if you can avoid the penalty. If you can’t avoid it, consider whether it’s worth paying for early access to 403(b) funds.
403(b) vs 401(k): How They Compare
The 403(b) is often referred to as a cousin to the 401(k), and the two plans are broadly similar. Annual contribution limits are almost entirely the same, and rules governing withdrawals are identical. Both allow pre-tax and post-tax Roth contribution options as well as employer contributions. But there are a few differences:
• Types of employers. The 401(k) plan is for private-sector employers while the 403(b) plan is for non-profit and certain government organizations.
• ERISA exemptions. The Employee Retirement Income Security Act (ERISA) protects employees and their retirement savings. Unlike private-sector companies offering 401(k)s, employers that offer 403(b) plans are not required to follow certain ERISA rules. Some plans may ignore the non-discrimination requirements that prevent some employees from receiving preferential treatment. Notably, these ERISA exemptions typically prevent organizations that offer 403(b) plans from making employer contributions.
• Extra contributions. The 403(b) plan enables bonus catch-up contributions of $3,000 per year for employees who’ve worked for the same organization for at least 15 years, up to $15,000 in total.
• Plan administration. Insurance companies generally administer 403(b) plans, which means they may predominantly offer annuities as retirement investments, which may not be the best investment choice, particularly for younger employees. 401(k) plans, on the other hand, are often administered by big financial services firms that offer a wider range of investment choices.
• Shorter vesting periods. Employer contributions to tax-advantaged retirement accounts often come with a vesting period. This means that employer contributions are not immediately the employee’s, and if they leave an employer before a certain amount of time, sometimes up to six years, they may forfeit some or all of their accrued employer contributions. 403(b) plans either lack vesting periods or offer relatively brief vesting periods.
Should You Invest in a 403(b)?
Investing in a 403(b) provides you with a tax-advantaged way to save for retirement and build wealth for the future. That said, depending on the investment options available in your 403(b), you may prefer to invest in a retirement account outside of your workplace, like an IRA.
