If you work in the corporate world, you probably have a retirement plan that is sponsored by your employer. Most salaried employees have what’s called a 401(k), but depending on the organization you’re with, you might have a 403(b) instead.
What is a 403(b) plan?
A 403(b) plan is a retirement plan that is specifically provided by non-profit companies. This includes organizations like religious groups, hospitals, universities and private schools, museums, and health foundations. Most government employees also have 403(b) retirement plans.
How does a 403(b) work?
When you have a 403(b) retirement plan, you make monthly contributions that usually come out of your paycheck, and you get to choose the contribution amount. It’s either a specific dollar amount, or a percentage of your monthly take-home pay.
Once the money hits your account, you can invest it in the stock market, and watch it grow overtime. When you turn 59 ½ , you’re able to withdraw the money from your 403(b) and use it to supplement your income during retirement. Technically, you can use the money from your 403(b) for any purpose.
If you find yourself in a situation where you need money fast, but you haven’t met the age requirement, you are allowed to pull out some or all of the money in your account. The catch is that you’ll pay a big penalty. Usually, it’s 10% of the withdrawal amount.
Much like a 401(k) account, there are two types of 403(b) plans:
- Traditional 403(b): With a traditional 403(b), your monetary contributions grow tax-free. When you withdraw the money later in life, you will pay taxes on the money.
- Roth 403(b): A Roth 403(b) has the opposite tax structure. You pay taxes on the contributions you make now, and when you are eligible to take the money out, you won’t owe any taxes.
What are the 403(b) contribution limits?
All retirement accounts have a contribution limit, which is the maximum amount of money you’re allowed to put into your account on an annual basis. For a 403(b), the 2021 contribution limit is $19,500, according to the IRS. If you’re over 50, you’re also allowed to make additional yearly “catch-up” contributions of $6,500.
Every employee with a 403(b) is subject to the maximum contribution limit, regardless of how much money they make, or how many years they’ve worked. However, if your employer matches your contribution, it doesn’t count toward the annual limit.
How to invest in a 403(b)
In order for your 403(b) account to grow, the money must be invested in the stock market. When you open a new account, you’ll have the option to choose which stocks you want to invest in by selecting high-performing mutual funds. Most plans also provide the option to invest in annuities.
Your company’s employee benefits administrator will provide a packet of information with a list of the mutual funds available and their growth charts. If you’re not sure which funds to invest in, you can probably speak with a financial advisor from the company who can recommend an investing strategy based on your risk tolerance and goals.
With a 403(b) plan, you are in full control of the account, which means you can buy and sell shares, and contribute to new funds at any point. Just remember that, unlike a brokerage account, you aren’t allowed to withdraw any of the money until you’re 59 ½ without paying a penalty.
How do 403(b) withdrawals work?
When you turn 59 ½, you’re allowed to withdraw the money from your 403(b) without any penalty. The withdrawal is called a distribution. If you have a traditional 403(b), you’ll pay taxes on the distribution when you take out the money, but if you have a Roth 403(b), you won't owe any taxes.
There are a few ways that 403(b) qualified distributions are handled, but it depends on the plan provider and your employer. Usually, you have the option to receive all the money in one lump sum, in regular increments over a certain period of time, or in amounts of your choice periodically.
If your account has grown significantly over your lifetime, it might be tempting to withdraw the money in full. However, keep in mind that any money that remains in your account will stay in the stock market, and will theoretically continue to grow even more.
Advantages of a 403(b)
Choosing a 403(b) has a few advantages over other retirement plans. Here are some of the biggest reasons to choose a 403(b) if your employer offers one:
- Tax savings: If you choose a traditional 403(b) that grows tax-deferred, it will lower your taxable income, which can be a smart financial decision. It can also help you build wealth by lowering your taxable income, while your money grows in the market.
- Catch-up payments: 403(b) plans allow you to make yearly catch-up payments once you turn 50, which gives you more opportunity to contribute, especially if you’re already maxing out the account.
- Employer matching contributions: If your employer will offer to match your contributions to a 403(b), it’s basically free money. An employer match also allows you to contribute more than $19,500 per year.
Disadvantages of a 403(b)
While 403(b) retirement plans can be beneficial, they also have a number of drawbacks that are important to consider. Here are some of the disadvantages of a 403(b):
- Limited investment options: A common issue with 403(b) plans is that the investment funds are usually limited. If you’re a confident investor that looks for riskier investments, you might find that a 403(b) doesn’t offer the best investment options.
- Required withdrawals: You can’t keep your money in a 403(b) forever. Once you turn 70 ½ (or the age you retire if it’s after that), you are required to take minimum distributions, or else you will pay a penalty.
- Potential penalties: As mentioned, you aren’t allowed to withdraw money from your 403(b) before 59 ½ without taking a penalty. Even if you retire at 58, you still have to wait until you’re eligible based on your age.
What’s the difference between a 401(k) and a 403(b)?
The 401(k) is arguably the most well known retirement plan, and it’s pretty similar to a 403(b). The main difference between a 401(k) and a 403(b) is the type of organization that offers each plan. As an employee, you can only get a 401(k) if you work for a for-profit company. If you work for a non-profit, you are usually given the option to invest in a 403(b).
Besides the type of company that offers these plans, there aren’t many other differences. Both plans have the same contribution limit ($19,500 per year) and allow for annual $6,500 catch-up payments after age 50. Additionally, both 401(k) and 403(b) plans can have an employer match.
However, there are a few important differences when it comes to the investing options. Generally speaking, 401(k) plans offer more investment options than 403(b) plans. With a 401(k), you can usually choose to invest in stocks, bonds, ETFs, mutual funds, and others. But if you have a 403(b), some plans limit your investment options to mutual funds and annuities only.
How to open a 403(b) account
The only way to open a 403(b) account is through your non-profit employer. When you first start the job, you’ll receive information on opening an account through the organization’s plan provider. You will also receive a list of the investment options, growth charts, fees, and other information, including your employer’s match (if there is one).
The process of opening a new 403(b) isn’t necessarily time consuming, but it will require you to submit personal information and decide which funds you want to invest in. If you’re rolling over an existing 401(k) into your new 403(b), it typically involves coordination with your previous employer’s plan provider.
If you didn’t opt into your employer’s 403(b) retirement plan when you first started, you can probably enroll at any time. Contact your company’s benefit administrator or human resources department to request the information needed to open a new account.
Once your account is set up, you’ll want to notify your benefits administrator if you wish to make contributions through your monthly paycheck. You get to decide how much—a set dollar amount or a fixed percentage—gets withheld from your paycheck and goes towards your retirement plan. You can change the amount at any time.
Frequently asked questions (FAQ)
What is a 403(b) catch up contribution?
A 403(b) has something called a catch-up contribution. After you turn 50, you’re allowed to make one extra payment per year, up to $6,500. Essentially, the catch-up payment allows you to accelerate your savings for retirement as you get closer to the end of your career.
If you haven't yet turned 50, but you have worked at your non-profit employer consistently for at least 15 years, you might be allowed to make catch-up payments anyways. It depends on your employer and your plan’s rules.
Can you contribute to both a 403(b) and 401(k)?
Yes, if your employer offers a 403(b) and 401(k), you’re allowed to contribute to both. But know that the maximum contribution limits are the same. If you put $19,500 in your 403(b), you wouldn’t be allowed to contribute any money to your 401(k) without facing penalties.
Contributing to both a 403(b) and 401(k) shouldn’t be used to double your retirement savings—it doesn’t work that way. However, if you have the opportunity to contribute to two plans, it could allow you to diversify your investments, which may help your money to grow faster.
What happens to my 403(b) if I quit my job?
If you leave your job, you’re allowed to keep your 403(b). However, the amount you’re able to keep will depend on how much money is vested vs. unvested.
When your employer matches your retirement contributions, that money is usually unvested until you have worked there for a certain amount of time, at which point the funds become vested. If you quit your job, you will only be allowed to keep the vested money, and any unvested money will go back to your employer.
If you leave your job and start working at a for-profit company, you’ll have to roll your 403(b) account into a 401(k) account. You won’t be able to continue making contributions to a 403(b) unless you move to another non-profit organization.
Can a 403(b) be rolled into an IRA?
Yes, you’re allowed to roll a 403(b) into an IRA. This is common among people who switch jobs or retire. If you choose this option, make sure the money from your 403(b) gets deposited directly into your new IRA account. If you collect the 403(b) funds with the intention of depositing them into the IRA account yourself, you’ll be subject to the 10% penalty if you are younger than 59 ½ .
Can I roll over a 403(b) to a 401(k)?
Yes, you can roll a 403(b) into a 401(k). The process is simple, and if you get a new job, your new company’s benefits administrator can help you. As mentioned with the 403(b) to IRA rollover, ensure that the money will be transferred directly to your 401(k), so it never touches your personal account.
Can I borrow money from my 403(b)?
If you need money in a pinch but don't want to take the 10% penalty for distributing early, you can borrow money from your 403(b). This essentially works like a loan, where you withdraw money from your account and pay it back with interest. The money you repay will go back into your retirement account, but the biggest downside is that the interest rates can be much higher than taking out a regular personal loan.