What is a 403(b) (Tax‑Sheltered Annuity)?
A 403(b) plan is an employer‑sponsored retirement account for employees of public schools, certain government agencies, and qualifying nonprofit (501(c)(3)) organizations. It is sometimes called a tax‑sheltered annuity (TSA). Like a 401(k), it lets workers set aside pay through payroll deductions and receive tax advantages for retirement saving.
Key features and definitions
– Tax‑deferred (traditional) contributions: Contributions are made before income tax, reducing taxable income in the contribution year. Taxes are due when money is withdrawn in retirement.
– Roth contributions: Contributions are made with after‑tax dollars; no immediate tax reduction, but qualified withdrawals (principal and earnings) are tax‑free. Not every employer offers a Roth 403(b).
– Catch‑up contribution: An additional contribution allowance for certain participants. Generally, workers age 50+ can add a catch‑up amount; some 403(b)s also permit extra catch‑ups based on long service with the employer.
– Vesting: The schedule that determines when employer contributions become the employee’s property. 403(b) plans often vest faster than 401(k) plans and some permit immediate vesting.
– Early withdrawal penalty: Withdrawals before age 59½ typically incur income tax plus a 10% penalty unless an exception applies (for example, separation from service at age 55 or older, disability, or certain medical expenses).
– Investment options: 403(b) plans commonly offer annuity contracts (including variable annuities) and a limited selection of mutual funds; individual stocks and many other asset types are often not allowed.
– Creditor protection: Some 403(b) assets may not have the same creditor protections as other retirement accounts, depending on plan terms and state law.
Who can get one
– Employees of public schools and colleges, certain government agencies, and nonprofit employers that qualify under IRS rules (typically 501(c)(3) organizations).
– Certain clergy can use a 403(b); religious employers sometimes use a specific 403(b)(9) arrangement.
Contribution limits (example year numbers)
– For 2025, the elective deferral limit is $23,500. That limit applies across 403(b) and 401(k) plans combined if you participate in more than one plan.
– The standard catch‑up for age 50+ in 2025 is an additional $7,500. Some 403(b) plans provide an extra catch‑up based on long service (for example, after 15 years with certain employers).
Advantages
– Tax relief today (traditional) or tax‑free withdrawals later (Roth).
– Potential for faster vesting of employer contributions.
– Possibility of higher employer flexibility on catch‑up contributions for long‑term employees.
– Available to many public and nonprofit workers who may not have access to a 401(k).
Disadvantages
– Fewer investment choices than many private‑sector plans (annuity contracts and limited mutual funds).
– Early withdrawals face taxes and usually a 10% penalty unless an exception applies.
– Not all plans include a Roth option.
– Some accounts may not have full creditor protection.
How taxation works
– Traditional 403(b): Contributions reduce taxable income in the year made; taxes are paid on withdrawals.
– Roth 403(b): Contributions are made with after‑tax dollars; qualified withdrawals are tax‑free.
– Early withdrawals before age 59½ are taxable and generally subject to a 10% penalty unless you meet an IRS exception (separation at age 55+, disability, qualified medical expenses, etc.). Taxes themselves are always owed on taxable distributions.
Checklist: Steps to evaluate or use a 403(b)
1. Confirm eligibility: Are you employed by a public school, qualifying nonprofit, or government agency?
2. Ask your employer: Does the plan offer a traditional option, a Roth option, or both? Is there an employer match? What is the vesting schedule?
3. Check contribution limits: Note the annual deferral limit and any age‑based or service‑based catch‑up rules for the current year.
4. Review investment lineup: Are annuities available? Which mutual funds are offered? Are prohibited investments listed?
5. Understand withdrawal rules: Learn the plan’s early withdrawal penalties, loan provisions (if any), and hardship rules.
6. Compare with other employer plans: If you have access to both a 401(k) and a 403(b), remember combined limits may apply.
7. Consider tax treatment: Decide whether traditional or Roth contributions make more sense for your tax situation.
8. Document employer contributions and vesting: Keep records of employer matches and how they vest.
Worked numeric example
Scenario: You earn $60,000 and choose to contribute $5,000 to a traditional 403(b) in a year when your marginal federal tax rate is 22%.
– Traditional 403(b): Your taxable income for the year falls to $55,000 ($60,000 − $5,000). Immediate federal tax saved ≈ $5,000 × 22% = $1,100. Taxes will be due on withdrawals in retirement.
– Roth 403(b): You contribute $5,000 after taxes; no immediate tax saving. If the account grows and you make qualified withdrawals later, neither the $5,000 nor the investment gains are taxed on distribution.
Note: This example only shows federal income tax effects and ignores state taxes, payroll taxes, investment returns, and future tax rates.
Common comparisons with 401(k)
– Both are employer‑sponsored, tax‑advantaged retirement accounts that allow salary deferrals.
– 403(b) plans often have more limited investment menus and typically include annuity contracts as an option.
– Contribution limits and many tax rules are aligned across 401(k)s and 403(b)s; some plan features (like catch‑up rules based on service) are more specific to 403(b) plans.
Useful sources
– Investopedia — 403(b) Tax‑Sheltered Annuity (TSA) Plan: https://www.investopedia.com/terms/1/403bplan.asp
– Internal Revenue Service (IRS) — IRC 403(b) Tax‑Sheltered Annuity Plans: https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans
– IRS — 401(k) limit increases to $23,500 for 2025 (news): https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000
– AARP — The Importance of Having a Plan for Retirement (survey summary): https://www.aarp.org
Educational disclaimer
This explainer is for general educational purposes only. It does not constitute personalized investment, tax, or legal advice. Rules, limits, and exceptions can change; consult a qualified tax professional, financial advisor, or the plan administrator for guidance specific to your situation.