What Is a 403b Plan and How Does It Work?

A 403(b) plan is a retirement savings vehicle for employees in the public and non-profit sectors. It allows individuals to contribute a portion of their salary directly into investment accounts to save for their post-employment years. These plans are established by employers like schools and charities to attract and retain workers, offering tax advantages to help savings grow through automated paycheck contributions.

Eligibility and Enrollment

Participation in a 403(b) plan is determined by the employer. These plans are available to employees of public education institutions, such as elementary schools, high schools, and universities. Employees of certain non-profit organizations designated as 501(c)(3) tax-exempt entities are also eligible, and certain ministers can participate.

The “universal availability” rule mandates that if an employer allows one employee to contribute through salary deferrals, they must extend the offer to nearly all employees. There are limited exceptions, such as for students who perform services for their school. As of 2025, eligibility must be extended to long-term part-time employees who complete at least 500 hours of service in two consecutive years.

The enrollment process begins by obtaining plan forms from the employer. Employees fill out a salary reduction agreement, which authorizes the employer to withhold a specified amount from each paycheck and deposit it into the 403(b) account.

Contribution Rules and Limits

Funds are added to a 403(b) plan through employee elective deferrals, where an employee agrees to have a portion of their salary withheld and deposited into their account. Some plans permit pre-tax contributions, which reduce current taxable income, while others allow for after-tax Roth contributions.

Employers can also contribute to their employees’ 403(b) accounts. These contributions often come as a matching contribution, where the employer matches a percentage of the employee’s savings. Another type is a non-elective contribution, where the employer contributes regardless of employee participation.

The Internal Revenue Service (IRS) sets annual limits on contributions. For 2025, the employee elective deferral limit is $23,500. This limit applies to the total amount an employee can contribute to their 403(b) and any other similar workplace retirement plan.

To help individuals nearing retirement save more, there are catch-up provisions. Employees age 50 or older are permitted to make an additional catch-up contribution of $7,500. Beginning in 2025, a higher limit is available for those ages 60 through 63, allowing for an $11,250 catch-up contribution.

A separate catch-up is available to employees with at least 15 years of service with a qualifying employer, such as an educational institution or hospital. This provision allows an additional contribution of up to $3,000 per year, with a lifetime maximum of $15,000.

An overall limit applies to the total of all contributions made to an employee’s account in a single year, including employee, employer, and catch-up amounts. For 2025, this comprehensive limit is the lesser of 100% of the employee’s compensation or $70,000.

Investment Options and Account Types

The investment options within 403(b) plans are determined by the vendors an employer has approved for their plan. Historically, the primary investment vehicle was an annuity contract issued by an insurance company, which provides a series of payments during retirement. Options have expanded to include custodial accounts that hold mutual funds, which pool money to purchase a diversified portfolio of stocks, bonds, or other securities.

Participants in a 403(b) plan have a choice between two account types with distinct tax structures. The traditional 403(b) is the most common. Contributions are made with pre-tax dollars, lowering current income tax liability. The investments grow tax-deferred, and withdrawals in retirement are taxed as ordinary income.

Many employers also offer a Roth 403(b) option. With a Roth account, contributions are made with after-tax dollars, so there is no immediate tax deduction. The advantage is that investments grow tax-free, and qualified withdrawals of both contributions and earnings during retirement are not subject to federal income tax.

The choice between a traditional and a Roth 403(b) depends on an individual’s financial situation and expectation of future tax rates. An employee who believes they will be in a higher tax bracket during retirement might prefer the Roth option. An employee who wants to lower their taxable income now might opt for the traditional 403(b). Any employer matching funds are always made on a pre-tax basis and will be taxable when distributed.

Withdrawals and Rollovers

Accessing funds from a 403(b) plan is governed by specific rules, primarily centered around the participant’s age. Normal distributions can begin once the account holder reaches age 59½. Withdrawals from a traditional 403(b) at or after this age are subject to ordinary income tax. For Roth 403(b) accounts, qualified distributions after age 59½ are tax-free, provided the account has been open for at least five years.

Taking money out before age 59½ results in a 10% early withdrawal penalty on top of the regular income tax owed. An exception exists if an employee separates from service with their employer during or after the year they turn 55, allowing penalty-free distributions from that employer’s 403(b) plan. Other exceptions include distributions due to total and permanent disability or death.

Some 403(b) plans permit participants to take loans against their account balance. Plan loans must be repaid with interest, typically over a period of five years. If a loan is not repaid according to its terms, the outstanding balance is treated as a taxable distribution and may be subject to the 10% early withdrawal penalty.

Hardship withdrawals may also be available for individuals facing an immediate and heavy financial need, as defined by the IRS. These situations can include certain medical expenses or costs to prevent eviction. The amount withdrawn is limited to what is necessary to satisfy the financial need and is subject to income tax and potentially the 10% penalty.

Upon leaving an employer, an individual has several options for their 403(b) account balance. They can often leave the funds in the old employer’s plan or execute a rollover. A rollover involves moving the money from the 403(b) plan directly into another tax-advantaged retirement account, such as an Individual Retirement Arrangement (IRA) or a new employer’s plan. A direct rollover avoids tax withholding.