A 403(b) is a retirement savings plan for employees of schools, nonprofits, and hospitals

A 403(b) account is a retirement savings plan offered by certain employers — mainly public schools, colleges, nonprofits, and tax-exempt hospitals. You contribute money from your paycheck before taxes are taken out, and that money grows tax-deferred until you withdraw it in retirement. The account is named after the section of the tax code that created it.

The main difference between a 403(b) and a 401(k) is who can offer it. A 401(k) is for employees of for-profit companies. A 403(b) is for employees of organizations that have tax-exempt status — usually schools and nonprofits. If your employer offers a 403(b), that is likely the only retirement plan available to you through work.

Money you put into a 403(b) reduces your taxable income for the year you contribute. You pay income tax on the money only when you withdraw it after age 59½. If you withdraw before that age, you typically owe a 10 percent penalty plus income tax on the amount withdrawn, unless you meet a narrow exception.

Key Takeaways

  • A 403(b) is offered by schools, nonprofits, hospitals, and other tax-exempt employers, not by for-profit companies.
  • You contribute pre-tax money from your paycheck, which lowers your taxable income in the year you contribute.
  • Your contributions and earnings grow tax-deferred, meaning you pay no tax on the growth until you withdraw the money.
  • You can contribute up to $23,500 per year in 2024, or $31,000 if you are age 50 or older and your employer allows catch-up contributions.
  • Withdrawals before age 59½ usually trigger a 10 percent penalty plus income tax, with limited exceptions for hardship or separation from service.

How contributions and investment growth work

You decide how much to contribute each pay period, and your employer deducts that amount from your paycheck before calculating your income tax. The money goes into an investment account in your name. You choose how to invest it — usually among mutual funds, annuities, or stable value funds offered by your plan.

The earnings on your contributions — dividends, interest, and capital gains — are not taxed while the money stays in the account. This tax deferral is a major advantage: your money compounds faster because you are not paying tax on the growth each year. You only pay tax when you take the money out.

The contribution limit for 2024 is $23,500 per year. If you are age 50 or older, you can contribute an additional $7,500 per year (called a catch-up contribution) if your employer plan allows it. These limits change each year based on inflation.

When you can withdraw money and what happens if you do

You can withdraw money from your 403(b) without penalty once you reach age 59½, regardless of whether you are still working. You can also withdraw without penalty if you separate from service (leave your job) at any age, though some plans have restrictions on this.

If you withdraw before age 59½ and you have not separated from service, you owe income tax on the withdrawal plus a 10 percent early withdrawal penalty. A few exceptions exist: withdrawals for an immediate and heavy financial hardship (defined narrowly by the IRS), withdrawals due to disability, and withdrawals made as part of a series of substantially equal periodic payments. These exceptions are strict and require documentation.

You must begin taking withdrawals by April 1 of the year after you turn 73. These are called required minimum distributions (RMDs). The IRS calculates how much you must withdraw each year based on your age and account balance. If you do not take the full amount, you owe a 25 percent penalty on the shortfall (reduced to 10 percent if you correct it within two years).

How a 403(b) differs from an IRA

A 403(b) and an IRA are both tax-advantaged retirement accounts, but they work differently. An IRA is an individual account you open on your own; a 403(b) is offered by your employer. An IRA has a much lower contribution limit — $7,000 per year in 2024, or $8,000 if you are 50 or older. A 403(b) allows you to save much more.

An IRA is portable: you keep it even if you change jobs. A 403(b) stays with that employer's plan unless you roll it over to an IRA or another employer's plan when you leave. An IRA also gives you more control over investments — you can open one at any brokerage and invest in almost any security. A 403(b) limits you to the investments your employer's plan offers.

You can have both a 403(b) and an IRA at the same time. However, if you have a 403(b) and you also contribute to a traditional IRA, your IRA contribution may not be tax-deductible, depending on your income. A financial advisor or tax professional can help you understand how this works for your situation.

Employer matching and vesting

Some employers offer matching contributions: they add money to your 403(b) based on how much you contribute. For example, an employer might match 50 percent of your contributions up to 6 percent of your salary. This is assistance programs, and you should contribute enough to capture the full match if your employer offers it.

Matching contributions are usually subject to a vesting schedule. Vesting means the employer's money becomes yours to keep. You might be 100 percent vested immediately, or the money might vest gradually over three to six years. If you leave before the money is fully vested, you forfeit the unvested portion. Your own contributions are always 100 percent vested immediately — the employer's match is what may have conditions.

Rolling over a 403(b) when you change jobs

When you leave a job, you can roll your 403(b) balance into an IRA or into another employer's 403(b) or 401(k) plan. A rollover moves the money directly from one account to another without triggering taxes or penalties. This is different from a withdrawal: if you withdraw the money and deposit it yourself, you have only 60 days to complete the deposit, and your employer will withhold 20 percent for taxes.

The cleanest option is a direct rollover: you ask your old employer's plan administrator to send the money directly to your new IRA or plan. You never touch the money, so there is no withholding and no time pressure. Most employers and financial institutions can process a direct rollover in two to four weeks.

If you roll into an IRA, you gain more investment choices and flexibility. If you roll into another 403(b) or 401(k), you keep the money in an employer plan, which may offer lower fees or better investment options depending on the plan. You can also leave the money in your old employer's plan if the balance is above a certain threshold (usually $5,000), though this is rarely the best choice.

Fees and how they affect your balance

A 403(b) plan charges fees for administration and investment management. These fees vary widely depending on your employer's plan and the investments you choose. Some plans charge a flat annual fee; others charge a percentage of your balance (called an expense ratio). Annuity-based 403(b)s often have higher fees than mutual fund-based plans.

Even small differences in fees add up over decades. A 0.5 percent annual fee costs much less than a 1.5 percent fee, and the difference compounds. Before you invest, ask your plan administrator for a fee disclosure document. This document lists all fees and expense ratios so you can compare your options.

Some employers offer low-cost index funds or stable value funds with expense ratios below 0.25 percent. If your plan offers these, they are usually the most cost-effective choice for long-term retirement savings.

Frequently Asked Questions

Can I have a 403(b) and a 401(k) at the same time?

No. A 403(b) and a 401(k) are both employer-sponsored plans, and the IRS treats them as a single plan for contribution limits. Your combined contributions to both cannot exceed $23,500 per year in 2024. However, you can have a 403(b) and an IRA at the same time, though your IRA deduction may be limited depending on your income.

What happens to my 403(b) if I die?

Your 403(b) passes to your beneficiary — usually your spouse or children — without going through probate. Your beneficiary can withdraw the money or roll it into an inherited IRA. The rules for inherited accounts are complex, so your beneficiary should speak with the plan administrator or a tax professional about their options.

Can I borrow from my 403(b)?

Many 403(b) plans allow loans, but not all. If your plan allows it, you can usually borrow up to 50 percent of your vested balance, with a maximum of $50,000. You repay the loan through payroll deductions, typically over five years. If you leave your job before repaying the loan, you usually must repay it within 60 days or it becomes a taxable withdrawal subject to the 10 percent penalty.

Is a 403(b) the same as a pension?

No. A pension is a defined benefit plan where your employer guarantees a specific monthly payment in retirement based on your salary and years of service. A 403(b) is a defined contribution plan where you and your employer contribute money, and your retirement income depends on how much you saved and how well your investments performed. Most schools and nonprofits now offer 403(b)s instead of pensions.

What if my employer does not offer a 403(b)?

You can open an IRA on your own through a bank, brokerage, or credit union. A traditional IRA works similarly to a 403(b) — your contributions may be tax-deductible, and earnings grow tax-deferred. An IRA has lower contribution limits and more investment choices than a 403(b), but it is a good option if your employer does not offer a workplace plan.