When it comes to employer-sponsored retirement savings accounts, a 401(k) might be the first one that comes to mind. But those plans can only be offered at for-profit companies. For public and nonprofit organizations, there is another type of retirement plan they can sponsor: a 403(b).
What is a 403(b) plan?
A 403(b) plan is a retirement savings account offered to employees of nonprofit organizations and other tax-exempt organizations including churches, public schools, and some government agencies.
403(b)s work similarly to 401(k) plans: An employee contributes pre-tax funds from their salary into a retirement account, where those savings are invested. The account-holder doesn’t pay taxes on the funds or any gains they generate until they withdraw them in retirement, when they will pay ordinary income taxes. Another similarity with a 401(k): Employers can also offer matching contributions to their employees’ 403(b).
There are two different types of 403(b) plans:
- Traditional 403(b). The traditional plan is funded with pretax earnings. Contributions to this plan lower the employee’s current taxable income, and the employee only pays taxes when the money is withdrawn in retirement.
- Roth 403(b). This plan is funded with after-tax dollars, meaning employees pay taxes on the money that goes into a Roth 403(b). But those funds then enjoy tax-free growth—meaning that later, when an individual withdraws money in retirement, they won’t owe any income taxes on that money.
The employer can decide whether to offer a 403(b), a Roth 403(b), or both. If an employer offers both, an employee can elect to have one or both accounts. If they choose to have both, they just can’t exceed the contribution limit ($20,500 in 2022) across the two accounts. Choosing which type of account to go with is based on whether they’d like to pay taxes later (a traditional plan) or now (a Roth plan).
How does a 403(b) work?
Once an employer chooses the type of 403(b) plan to offer, it’s easy for employees to contribute to their own plan. Some plans may even automatically enroll employees as participants. If there’s no automatic enrollment, employees will elect to participate in the plan.
To get started, in most instances, the employee will determine how much of their paycheck they would like to contribute to the account each pay period. Then they will select the mutual funds that they want their savings invested in. Note that the Internal Revenue Code limits the types of investments for 403(b) plans to mutual funds and annuities, which often have higher administrative fees.
Once a plan is set up, their contributions will be automatically deducted from the employee’s pay. With a traditional 403(b), this contribution lowers the individual’s overall taxable income. For a Roth 403(b), taxes are withheld on the employee’s income, then the contribution is deducted and deposited into the account. The funds are then invested in whatever fund or combination of funds the employee chooses.
Funds in a 403(b) account are meant to stay there until retirement. The IRS levies a 10% penalty on early withdrawals, in addition to ordinary income tax. However, some 401(k) and 403(b) plans do allow individuals to withdraw funds from either of these accounts earlier without penalty if they turn 55 and retire.
Contribution limits for a 403(b) plan
In 2022, the contribution limit for employer-sponsored retirement accounts, including 403(b) accounts, is $20,500 for those under the age of 50. This is up from a limit of $19,500 in 2021.
That limit covers contributions to all qualifying retirement plans (including 401(k)s, Solo 401(k)s, SIMPLE IRAs, and SIMPLE 401(k)s). So if an employee is saving in a 403(b) and another plan like a Solo 401(k), they can only save a total of $20,500 between the plans.
There are exceptions made for older employees who are closer to retirement. An employee aged 50 or older can save an additional $6,500 in 2022 as a catch-up contribution, for a total of $27,000.
403(b) plans offered by some qualifying institutions (including hospitals and schools) also have a particular exception to the contribution rules for those with tenure: If an employee has worked at the non-profit organization for 15 years or more, they can save another $3,000 a year in their 403(b).
Employers can also contribute to an employee’s 403(b). The total limit for contributions to a 403(b) including all employee and employer contributions for 2022 is $61,000 for a worker under the age of 50. If the employee earned less than $61,000, the total contribution limit is the same as their salary.
403(b) vs. 401(k): similarities and differences
403(b)s and 401(k)s are both tax-advantaged retirement savings vehicles sponsored by employers. However, there are also differences between the two, starting with the type of employer that can offer a 403(b).
Similarities between 403(b) and 401(k) plans:
- Employer-sponsored. Both are retirement plans offered by employers, and both allow employers to contribute to their employees’ accounts.
- Contribution limits. Both retirement plans have the same contribution limits, including a catch-up provision for savers 50 and older.
- Early withdrawal penalties. The IRS will impose penalties on individuals if they draw money from both a 401(k) and 403(b) before age 59 ½.
- Investment options. Both plans can invest in mutual funds.
- Rollover options. Both plans can be rolled over into other ones. For example, if an individual leaves a job at a for-profit company and takes a new job at a nonprofit, they can roll over their 401(k) account into a 403(b) plan.
- Type of employer that can offer the plan. A 401(k) plan is offered by for-profit companies, whereas a 403(b) is offered by non-profit organizations and other similar entities.
- Catch-up provision by tenure. The 403(b) has a unique additional catch-up provision. If an employee has been at the nonprofit for 15 years or more, they can save $3,000 more each year in their 403(b).
- Investment options. While 403(b)s are limited to mutual funds and annuities, 401(k)s typically have more investment options, including stocks, bonds, and exchange-traded funds.
- Protections. 401(k)s are covered by the Employee Retirement Income Security Act (ERISA), a federal law requiring employers and providers to adhere to certain financial standards that are meant to protect employees’ retirement income. If a 403(b) plan doesn’t offer matching contributions, it may not be covered by ERISA.
The bottom line
A 403(b) plan is not as common a retirement savings plan as a 401(k) since only a subset of employers can offer 403(b) plans. However, 403(b) plans share a lot of similarities with the more widely known 401(k)—including contribution limits and early withdrawal penalties. 403(b)s also have one particular benefit: A unique catch-up contribution for those with tenured employment, which rewards long-term service to an employer.