Planning for retirement can seem daunting, but it’s essential to securing a stable financial future. For those working in public schools, nonprofit organizations and some churches, a 403(b) plan offers an effective, tax-advantaged way to save for retirement. A 403(b) plan offers a host of benefits that can significantly enhance your financial security during your golden years.

Whether you’re already enrolled in a 403(b) plan or considering one for the first time, it’s important to understand how these plans work, their benefits and potential risks.

What are the benefits of contributing to a 403(b)?

A 403(b) plan is a retirement savings plan available to employees of public schools, churches and certain 501(c)(3) nonprofit organizations. Named after the section of the IRS code that governs it, the 403(b) plan allows eligible employees to make contributions to a tax-advantaged retirement account.

Like a 401(k) plan, a 403(b) plan offers both a traditional and Roth option, each of which provide various tax benefits.

Traditional 403(b)

A traditional 403(b) plan offers several advantages:

  • Pre-tax contributions: Pre-tax contributions reduce your taxable income in the year you contribute.
  • Tax-deferred growth: Your contributions grow tax-free until you make withdrawals in retirement, providing significant tax savings.
  • Regular catch-up contributions: Employees age 50 and older can contribute up to an additional $7,500 in catch-up contributions in 2024.
  • Additional catch-up contributions: Employees with at least 15 years of service with the same employer may be permitted to defer an extra $3,000 per year over and above normal IRS deferral limits (up to a lifetime limit of $15,000).
  • Investment options: Some 403(b) plans offer potentially high-return investments, including stock funds.

Roth 403(b) plan

A Roth 403(b) plan provides these additional benefits:

  • No required minimum distributions: Unlike traditional 403(b) plans, Roth 403(b) plans do not require minimum distributions during the account owner’s lifetime.
  • Tax-free withdrawals in retirement: You can withdraw money tax- and penalty-free starting at age 59 ½.
  • Catch-up contributions: Like its traditional counterpart, a Roth 403(b) allows catch-up contributions for those age 50 and older, as well as a 15-year catch-up contribution if the employer allows it.
  • Investment options: You can purchase potentially high-return investments such as mutual funds within a Roth 403(b) and enjoy tax-free growth.

A 403(b) comes with other benefits as well. While not all 403(b) plans offer employer matching contributions, many do. The specifics of employer matching contributions vary from plan to plan, but when available, they can help boost the value of your retirement savings.

Additionally, if your plan allows it, you can take a loan from your 403(b) account. However, many experts advise against taking out loans from your 403(b) account because it diminishes the amount left for your retirement. Even though the money must ultimately be repaid, you’ll miss the potential for growth over time via compounding.

Who is eligible to participate in a 403(b) plan?

Eligibility for a 403(b) plan is extended to employees of public schools, certain tax-exempt organizations, churches and certain ministers. These include civilian faculty and staff of the Uniformed Services University of the Health Sciences, ministers employed by Section 501(c)(3) organizations and self-employed ministers.

Contribution limits for a 403(b) plan

Employees can contribute up to $23,000 to a 403(b) in 2024. Those over age 50 can also contribute up to an additional $7,500 in catch-up contributions.

Regardless of age, employees with at least 15 years of service with the same employer and an average annual contribution of less than $5,000 per year may be permitted to defer an extra $3,000 per year over and above normal IRS deferral limits (up to a lifetime limit of $15,000 for this type of catch-up contribution). Be aware that not all employers offer catch-up contributions based on the 15-year rule.

For plans with employer contributions, you can contribute up to 100 percent of your salary, or $69,000 (in 2024), whichever is less. This limit rises to $76,500 for those 50 or over. Contributions made above the IRS elective deferral limits are made on an after-tax basis.

Risks and penalties associated with a 403(b) plan

While a 403(b) plan offers many benefits, you should also be aware of the potential risks and penalties associated with early withdrawals and market fluctuations.

  • Fluctuating value: While your contributions and any employer matching are secure, the value of your investments can fluctuate with market conditions, meaning you could potentially lose some of the money you’ve invested.
  • Early withdrawal penalties: Withdrawals from a 403(b) plan before age 59 ½ are subject to a 10 percent early withdrawal penalty in addition to the potential for income tax. However, certain exceptions exist, such as if the withdrawal is made due to disability, death, or under the 72(t) rule for substantially equal periodic payments.
  • Investment fees: No matter what you choose to invest in, there will always be costs attached to the funds you buy. These fees can impact your long-term returns, so it’s crucial to try and reduce them as much as possible.

How is a 403(b) different from a 401(k)?

Both 403(b) and 401(k) plans are tax-advantaged, offer a traditional and Roth option, allow for employer matching and have early withdrawal penalties. However, these retirement accounts aren’t identical. Here are some of the biggest differences:

  • Offered by different employers: A 403(b) plan is generally offered by public schools, churches and non-profit organizations, whereas a 401(k) plan is typically provided by for-profit companies.
  • Different investment options: A 403(b) plan tends to have a more limited range of investment options, often restricted to annuities and mutual funds, while 401(k) plans usually offer a broader array of investment choices including stocks, mutual funds and bonds.
  • Additional catch-up contribution: 403(b) plans offer a special catch-up contribution for employees with 15 years of service, which is not available to 401(k) participants.

These plans also have further technical and legal differences that are more relevant to those looking to implement one of the plans.

Bottom line

A 403(b) is an effective vehicle for employees of nonprofit, government and religious organizations to save for retirement, offering tax advantages, potential employer matching contributions and high contribution limits. However, it’s important to understand potential risks and penalties associated with your plan. As with all retirement planning decisions, it’s wise to consult with a financial advisor to ensure you’re making the best choices for your circumstances.