What is a 403(b) Tax-Sheltered Annuity Plan?
A 403(b) is a retirement plan offered by public schools and non-profit organizations, functioning similarly to a 401(k) plan. Specifically designed for employees of tax-exempt organizations, a 403(b) plan includes participants such as teachers, school administrators, professors, government employees, nurses, doctors, and librarians.
Key Takeaways
- The 403(b) Tax-Sheltered Annuity Plan serves employees of public schools and tax-exempt organizations.
- Contributions to 403(b) plans are made through payroll deductions.
- The IRS limits how much employees can contribute to their 403(b) plans.
- Investment choices might be more limited with a 403(b) compared to 401(k), and some accounts offer less protection from creditors.
How Contributions to 403(b) Work
The 403(b) plan allows participants to save money for retirement through payroll deductions while enjoying specific tax benefits. Employers may also match part of an employee’s contributions. However, contribution limits are set by the Internal Revenue Service (IRS).
Like a 401(k) for private-sector employees, participants in a 403(b) must be at least 59½ years old to withdraw funds without facing an early withdrawal penalty. Eligible contributors include:
- Employees of public schools, state colleges, and universities
- Public school employees of Indian tribal governments
- Church employees
- Employees of tax-exempt 501(c)(3) organizations
- Ministers and clergy members
If an employer offers both 403(b) and 401(k) plans, individuals can contribute to both, but their aggregate contributions can’t exceed the annual IRS limit of $23,000 in 2024. Individuals aged 50 and over can contribute an additional $7,500 as catch-up contributions.
Types of 403(b) Tax-Sheltered Annuity Plans
Traditional 403(b): Allows employees to have pretax money automatically deducted from each paycheck and paid into a personal retirement account, thus reducing their gross income and income tax for the contribution year. Taxes are due upon withdrawal.
Roth 403(b): Contributions are made with after-tax money. Unfortunately, there is no immediate tax advantage, but employees won’t owe any more taxes on the withdrawn amount or its earnings.
403(b)(9): Special plan type intended for clergy and employees of religious institutions.
Advantages of 403(b) Plans
- Tax Benefits: Earnings and returns on contributions are tax-deferred until withdrawal in regular plans. For Roth 403(b), they are tax-free if withdrawals are qualified.
- Vesting Periods: Funds often vest over shorter periods than in 401(k) plans, and some funds even vest immediately.
- Catch-Up Contributions: Employees with 15 or more years of service at certain nonprofits can make additional catch-up contributions of $3,000 per year, up to a $15,000 lifetime limit.
Disadvantages of 403(b) Plans
- Withdrawal Penalties: Withdrawals before age 59½ incur a 10% tax penalty, unless specific conditions are met.
- Investment Choices: The investment choices may be narrower than those offered by other plans, such as stocks or REITs.
- Creditor Protection: Accounts in a 403(b) might lack the creditor protection provided by other plans.
Similarities Between 401(k) and 403(b)
Both offer a tax-advantaged way to save for retirement. However, investment options in a 403(b) plan may be more limited than in a 401(k). Unique to 403(b), employees who have served 15 or more years with the same employer have access to special catch-up contributions that are not available in a 401(k).
When is Money in a 403(b) Plan Taxed?
Deferred salary in a 403(b) is not subject to federal or state income tax until the money is distributed. However, contributions to designated Roth accounts are taxed in the income year and are tax-free during distribution.
Eligible Employers
Public educational institutions or 501(c)(3) tax-exempt organizations are the only entities that can establish a 403(b) plan.
The Bottom Line
A 403(b) plan, available through public schools and other tax-exempt organizations, closely resembles a 401(k) in many aspects and includes the potential for matching contributions. The IRS mandates annual contribution limits to 403(b) Tax-Sheltered Annuity Plans.
Related Terms: 401(k), TSA, Roth 403(b), 501(c)(3), catch-up contributions
References
- Internal Revenue Service. “Retirement Topics - Exceptions to Tax on Early Distributions”.
- Internal Revenue Service. “IRC 403(b) Tax-Sheltered Annuity Plans”.
- Internal Revenue Service. “How Much Salary Can You Defer if You’re Eligible for More than One Retirement Plan?”
- Internal Revenue Service. “Retirement Topics - Designated Roth Account”.
- Internal Revenue Service. “Retirement Topics - 403(b) Contribution Limits”.
- Internal Revenue Service. “Section 403(b) Tax-Sheltered Annuity Arrangements”. Page 1.
- Internal Revenue Service. “Retirement Plan Investments FAQs”.
- Financial Industry Regulatory Authority. “401(k) Basics”.
- Internal Revenue Service. “IRC 403(b) Tax-Sheltered Annuity Plans”.
