403(b) Plan

A 403(b) plan (written variously as a 403b or 403 b plan) is a retirement account for certain employees of public schools and tax-exempt organizations. Participants include teachers, school administrators, professors, government employees, nurses, doctors, and librarians. Religious ministers may also participate in these plans; although, there’s also a special plan type, a 403(b)(9), that’s designed specifically for churches.

The features and advantages of a 403(b) plan are largely similar to those found in a 401(k) plan. Both have the same basic contribution limits— $19,500 in 2020 ($19,500 in 2019). The combination of employee and employer contributions are limited to the lesser of $57,000 in 2020 ($56,000 in 2019) or 100% of the employee’s most recent yearly salary. Both also offer Roth options and require participants to reach age 59½ to withdraw funds without incurring a penalty. Like a 401(k), the 403(b) plan offers $6,500 catch-up contributions for those age 50 and older ($6,000 in 2019). It also offers a special plan for those with 15 or more years of service with the same employer (see below).

Though it is not very common, your job situation could end up giving you access to both a 401(k) and a 403(b) plan. In these cases, employees may contribute to both accounts. However, your aggregate contribution to both plans cannot be more than the $19,500 ($19,000 in 2019) limit, not counting any 401(k) catch-up contribution.

Earnings and returns on amounts in a regular 403(b) plan are tax-deferred until they are withdrawn. Earnings and returns on amounts in a Roth 403(b) are tax-deferred if the withdrawals are qualified distributions.

Employees with a 403(b) may also be eligible for matching contributions, the provision of which varies by employer. Plans that do not offer such employer matches deprive employees of the essentially free money these provide, but they may lead to lower customer costs. Those 403(b)s that lack matching contributions are not required to meet the onerous oversight rules of the Employee Retirement Income Security Act (ERISA), which means that their administrative fees may be lower than for 401(k)s or other funds subject to greater oversight. (However, non-ERISA status also comes with some potential drawbacks for account holders, as noted below.)

Many 403(b) plans vest funds over a shorter period than 401(k)s, and some even allow immediate vesting of funds, which 401(k)s rarely do. Also, if an employee has 15 or more years of service with certain nonprofits or government agencies, they may be able to make additional catch-up contributions to a 403(b) plan that those who have a 401(k) plan can’t. Under this provision, you may contribute an additional $3,000 a year up to a lifetime limit of $15,000. And unlike the usual retirement-plan catch-up provisions, you don’t have to be 50 or older to take advantage of this. But you do have to have worked for the same eligible employer for the whole 15 years.

As with a 401(k), funds withdrawn from a 403(b) plan before age 59½ are subject to a 10% tax penalty, although you may avoid the penalty under certain circumstances, such as separating from an employer at age 55 or older, needing to pay a qualified medical expense, or becoming disabled.

A 403(b) may offer a narrower choice of investments than the other types of retirement plans. The reason: 401(k)s tend to be administered by mutual fund companies and so offer a host of these diverse and versatile investment options. Most 403(b) plans now offer mutual fund choices as well, albeit inside a variable annuity contract in most cases. However, fixed and variable contracts and mutual funds are the only types of investments permitted inside these plans; other securities, such as stocks and real estate investment trusts (REITs), are prohibited.

The presence of an investment option that 403(b)s favor is, at best, a mixed blessing. When the 403(b) was invented in 1958, it was known as a tax-sheltered annuity. While times have changed, and 403(b) plans can now offer mutual funds, as noted, many still emphasize annuities. These investments have some advantages, but financial advisors often recommend against investing in annuities in a 403(b) and other tax-deferred investment plans for a variety of reasons.

Note that 403(b)s that don’t have ERISA protection, as is typically the case for those that lack employer matches, may lack the same level of protection from creditors as types that require ERISA compliance, including 401(k)s. If you are at risk of creditors pursuing you, speak to a local attorney who understands the nuances of your state. The laws can be complex.

Other disadvantages of non-ERISA 403(b)s include their exemption from nondiscrimination testing. Done annually, this testing is designed to prevent management-level or highly compensated employees from receiving a disproportionate amount of benefits from a given plan. Also, the lack of ERISA protection means that the plan doesn't have to follow ERISA standards to ensure plan safety.