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

Saving for retirement is essential, and employer-sponsored plans help build long-term financial security. While many are familiar with 401(k) plans, fewer understand how a 403(b) plan works and who it benefits.

This type of retirement account has unique features, particularly regarding eligibility, contributions, and tax treatment. Understanding these details helps employees make informed savings decisions.

Eligibility Criteria

A 403(b) plan is available to employees of tax-exempt organizations, public schools, and certain ministers. Eligibility depends on the employer’s tax-exempt status under the Internal Revenue Code. Qualifying organizations include nonprofit hospitals, religious groups, and educational institutions such as universities and K-12 public schools. Private-sector employees do not qualify.

Public school employees—including teachers, administrators, and support staff—qualify if they work for a state, county, or municipal school system. Employees of cooperative hospital service organizations and some tribal government entities may also participate. Ministers can enroll if they work for a tax-exempt organization or are self-employed clergy with ministerial earnings. However, clergy members serving congregations that do not meet tax-exempt criteria may not be eligible.

Employers must offer the plan to all eligible employees without discrimination based on tenure, job classification, or salary. However, part-time employees working fewer than 1,000 hours per year may face restrictions under federal law. Some employers impose a waiting period before new hires can participate.

Employer Contributions

Employers may contribute to a 403(b) plan in three ways: matching, non-elective, or discretionary.

Matching contributions depend on employee deferrals. For example, an employer might match 50% of an employee’s contributions up to 6% of their salary, effectively adding 3% to their retirement savings.

Non-elective contributions are made regardless of employee contributions. Universities and nonprofit healthcare organizations often use these to attract and retain talent in competitive fields. Employees receive these funds without needing to contribute their own money.

Discretionary contributions are not guaranteed and depend on an organization’s financial performance. These are more common in nonprofits reliant on fluctuating funding sources, such as grants.

Contribution Caps and Catch-Up

The IRS sets annual limits on 403(b) contributions. In 2024, employees can contribute up to $23,000 through salary deferrals. This limit is adjusted periodically for inflation.

Employees aged 50 or older can make additional catch-up contributions of $7,500 in 2024, increasing their total limit to $30,500.

A special catch-up provision applies to employees with at least 15 years of service at the same qualifying employer, such as a public school or nonprofit. They may contribute an extra $3,000 per year, up to a lifetime maximum of $15,000. However, eligibility depends on prior contributions and total years of service, requiring careful record-keeping.

Withdrawal and Distribution Rules

Withdrawals from a 403(b) plan follow specific regulations to encourage long-term savings. Funds are generally inaccessible until certain conditions are met, such as reaching a specific age, experiencing financial hardship, or leaving the employer.

Age Requirements

Distributions are allowed once an account holder reaches age 59½. Required Minimum Distributions (RMDs) must begin by April 1 of the year following the participant’s 73rd birthday, per the SECURE 2.0 Act of 2022. Failure to take RMDs results in a 25% penalty, which can be reduced to 10% if corrected within two years. Employees who continue working past 73 may defer RMDs if they remain with the same employer and do not own more than 5% of the organization.

Tax Penalties

Early withdrawals before age 59½ incur a 10% penalty in addition to ordinary income tax. For example, a $10,000 early withdrawal by someone in the 22% tax bracket results in $2,200 in income tax and a $1,000 penalty, leaving a net withdrawal of $6,800.

Exceptions to the penalty include permanent disability, medical expenses exceeding 7.5% of adjusted gross income, and qualified birth or adoption expenses up to $5,000 per child. Distributions under a Qualified Domestic Relations Order (QDRO), which divides retirement assets in divorce, are exempt from penalties but still subject to income tax.

Hardship Distribution

A hardship distribution allows employees to withdraw funds for an immediate financial need. Eligible expenses include medical bills, funeral costs, tuition, and preventing eviction or foreclosure. Unlike loans, hardship withdrawals do not require repayment but are subject to income tax and may incur the 10% early withdrawal penalty if taken before age 59½.

Employers must follow specific criteria to determine eligibility, ensuring withdrawals are limited to the necessary amount. Some plans require employees to exhaust other financial resources before approving a hardship withdrawal. The Bipartisan Budget Act of 2018 removed the requirement for employees to suspend contributions after taking a hardship withdrawal, allowing them to continue saving for retirement.

Tax Implications

The tax treatment of a 403(b) plan depends on whether contributions are made to a traditional or Roth account.

Traditional 403(b) contributions are made pre-tax, reducing taxable income in the year of contribution. Withdrawals in retirement are taxed as ordinary income. For example, an individual earning $80,000 in the 22% tax bracket who contributes $10,000 to a traditional 403(b) reduces their taxable income to $70,000, saving $2,200 in federal taxes for that year.

Roth 403(b) contributions are made with after-tax dollars, meaning they do not provide an upfront tax deduction. However, qualified withdrawals—including earnings—are tax-free if the account holder is at least 59½ and has held the account for at least five years.

For employees in higher tax brackets during their working years, pre-tax contributions provide immediate tax savings. Younger employees or those expecting to be in a higher tax bracket in retirement may benefit more from a Roth 403(b), as tax-free withdrawals offer greater long-term savings. Some employers offer both options, allowing participants to diversify their tax exposure.

Recent Plan Updates

Regulatory changes have impacted 403(b) plans, particularly regarding contribution limits, required distributions, and investment options. The SECURE 2.0 Act of 2022 raised the RMD age from 72 to 73 and increased catch-up contributions for employees aged 60 to 63 starting in 2025. Employers can now make matching contributions to Roth 403(b) accounts, which are included in the employee’s taxable income for the year they are made but grow tax-free.

Another significant change allows 403(b) plans to invest in collective investment trusts (CITs), which were previously restricted to 401(k) plans. CITs often have lower fees than mutual funds, potentially improving investment returns. However, implementation depends on plan providers updating their offerings. Employees should review plan documents and consult financial advisors to understand how these changes affect their retirement strategy.