403(b) Plan

What Is a 403(b) Plan?

A 403(b) plan is a retirement savings plan for employees of public schools, public colleges and universities, hospitals, and other organizations that are tax-exempt under section 501(c)(3) of the Internal Revenue Code. Some ministers and religious workers are also eligible. The plan takes its name from the section of the tax code that created it. It works much like a 401(k) plan offered by private companies, and it is one of the main workplace retirement options in the nonprofit and public education sectors.

How It Works

Employees choose to have part of each paycheck directed into the plan. These payroll contributions are called salary deferrals. Traditional contributions are usually made before income tax is withheld, which lowers taxable income for the year and lets investment earnings grow tax-deferred until money is withdrawn. Many plans also offer a Roth account option, where contributions are made after tax and qualified withdrawals are tax-free.

Employers may add their own money, often as a matching contribution tied to the employee's deferrals. Employer contributions can be subject to a vesting schedule, which determines when the employee fully owns them.

Historically, plan investments were limited to annuity contracts and mutual funds held in custodial accounts. Many plans now offer a broader menu, but the investment options still depend on how each plan is set up. The IRS sets annual limits on contributions, and those limits change over time.

Withdrawals and Penalties

Withdrawals taken before age 59½ are generally subject to income tax and an additional 10% early withdrawal tax, although several exceptions exist. Federal law also requires holders to begin taking a required minimum distribution once they reach a certain age. Those distributions are taxed as ordinary income unless they come from a Roth account.

Why It Matters to Investors

For eligible workers, a 403(b) plan can be a central part of retirement planning, offering tax advantages and convenient payroll deductions. The plan also has trade-offs. Annuity products sometimes carry higher fees than lower-cost mutual funds, investment choices may be limited, and early withdrawals are penalized. Understanding the plan's fees, investment options, and vesting rules helps explain how much of the account a worker would keep if they changed jobs.