retirement plan

What Is A 403b Retirement Plan And Is It Right For You?

Lauren Nowacki5-minute read
February 01, 2022

When setting long-term financial goals, saving for retirement should be at the top of your list. If you’ve given any thought to your life beyond employment, it’s probably involved a 401(k). However, most people aren’t familiar with another savings plan within the retirement family: a 403(b). This savings plan is similar to a 401(k) but has specific eligibility requirements. Find out if a 403(b) retirement plan is the right option for setting up a healthy financial future.

What Is A 403(b) Plan?

A 403(b), also known as a tax-sheltered annuity plan, is a retirement plan for employees of public schools, nonprofits and other tax-exempt organizations. Although this plan is similar to a 401(k), its biggest advantage is reducing taxable income. Investors can also use catch-up contributions to maximize their long-term savings.

Not everyone is eligible for a 403(b). Those who are eligible for one include:

  • Nonprofits eligible for tax exemption through IRC Section 501(c)(3)
  • Public school employees
  • Employees of hospital service organizations
  • Government employees

While ministers and some employees of religious institutions are eligible for a 403(b), there is a plan specifically for religious organizations called a 403(b)(9).

The 403(b)’s counterpart, the 401(k), is for all other employees belonging to tax-qualified organizations. While it’s uncommon, some people may be able to access and contribute to both plans. If you don’t know which plan you’re eligible for, check with your employer or financial advisor.

Contribution Limits Of A 403(b) Retirement Plan

Contribution limits are in place to even the playing field for average earners versus high earners. Limits will vary by the type of plan you have and your age. Here’s what the contribution limits of a 403(b) retirement plan are for 2020: 

  • Employees under age 50 can contribute up to $19,500.
  • Employees age 50 or older can make an additional $6,500 contribution. This is called a “catch-up” contribution.
  • Employees who have worked at the same eligible employer for 15 years or longer can contribute another $3,000 per year up to a $15,000 lifetime limit, no matter their age.
  • The limit of total annual contributions (employer matching programs in addition toelective employee deposits) for employees under 50 is either the $57,000 or the employee’s total compensation – whichever is less.
  • The limit of total annual contributions for employees who are 50 or older is $63,500 (including catch-up contributions) or the employee’s total compensation – whichever is less.

The 2020 contribution limits for a 403(b) are the same as the limits for a 401(k) and both may be increased in the future due to cost-of-living adjustments.

Employer Matching With A 403(b) Retirement Plan

Similar to a 401(k), your employee can choose to match your contributions. There are two types of contributions they can make:

A nonelective contribution is when the employer contributes a certain amount to an employee's retirement plan whether the employee contributes or not. The employer does not take money from the employee’s salary to make this contribution. The money comes from the employer.

A matching contribution is when your employer matches your contribution up to a certain amount. One common employer match for both a 401(k) and 403(b) is $.50 on every dollar you contribute, for up to 3% – 6% of your pay.

With a 403(b), there is often a shorter vesting period. Meaning you typically won’t have to wait as long as an employee with a 401(k) to keep an employer’s contributions to the retirement savings account.

Withdrawing Your 403(b) Retirement Plan

A 403(b) comes in two types of plans and both are the same as with the 401(k). Depending on what plan you choose, you will either be taxed on the money you contribute or the money you withdraw.

Traditional 403(b) plans are tax-deferred, which means the money is taken out of your paycheck before taxes are taken out. Instead, you’ll be taxed on the money when you eventually take it out.

Roth 403(b) plans are not tax-deferred. The contribution is made with after-tax dollars, but you won’t be taxed on the money when you withdraw it.  

Of course, there are some stipulations that come with withdrawing from your 403(b). With both traditional and Roth plans, you must be at least 59½ years old to withdraw your funds. If you withdraw money from your account before that age, you will incur a penalty fee, which is an additional 10% early withdrawal tax. There are some exceptions to this tax listed on irs.gov.

Pros And Cons Of A 403(b) Plan

When choosing a 403(b) savings plan over a 401(k) – if you have the choice – consider these pros and cons.

Pro: Catch-up provisions and the aforementioned 15-year employee benefit can help you maximize your retirement savings. This is especially helpful for those who miscalculate how much money is needed for retirement and fall behind where they should be.

Pro: With a shorter vesting schedule, you may be able to leave your job earlier with 100% of your employer’s contribution.

Pro: Your contributions can reduce your taxable income, which can put you in a lower tax bracket.

Con: There are limitations on where you can invest your money. For example, stocks and real estate investments are prohibited.

Con: Some 403(b)s are not protected by the Employee Retirement Income Security Act, which means they do not have the same protection from creditors and are also exempt from nondiscrimination testing.

Tips For Building A Successful 403(b) Portfolio

The first step in creating a successful 403(b) savings plan is understanding what it is and opening one, if you’re eligible. Here are a few other tips:

  • If your employer offers matching, adjust your investment to receive all matching dollars available to you. This is basically free money.
  • Don’t borrow from your 403(b) until you are 59½ or older.
  • Monitor your investments and reevaluate or adjust your investments each year.

Even More Resources

Looking for more advice on setting yourself up for financial success? Check out the Rocket HQSM blog for more information on such personal finance topics as saving for retirement, investing and paying off debt. You’ll have even more financial resources at your fingertips when you sign up for a Rocket HomesSM account. You’ll gain access to such helpful tools as a credit score simulator and home affordability calculator and receive a free TransUnion®credit report, updated weekly.

Remember, everyone’s financial situation is different and it’s best to speak with a licensed financial expert or advisor before making any major financial decisions.

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Lauren Nowacki

Lauren Nowacki is a staff writer specializing in personal finance, homeownership and the mortgage industry. She has a B.A. in Communications and has worked as a writer and editor for various publications in Philadelphia, Chicago and Metro Detroit.