What Is a 403(b) Plan? Here’s How It Works.

No matter where you work, you’ve got lots of options for saving for retirement. If you work for a private company, it’s likely you’ve set up a 401(k) through your employer. But if you’re an employee at a public school or a nonprofit organization, saving for retirement might look a bit different than it does for those in the private sector. That’s because 401(k)s are offered only through private employers.

The good news is that public school employees still have a similar option; it just has a different name: a 403(b) plan. While many public school employees still have a traditional pension, they may also have the option of contributing to a 403(b) plan to save additional dollars for retirement. We’ll help you understand what a 403(b) plan is and how it works to help you decide if it could be a good addition to your retirement savings plan.

What is a 403(b) plan?

Like a 401(k) or IRA, a 403(b) plan is a tax-advantaged savings vehicle that you can use to save for retirement. However, 403(b) plans are typically offered only to certain employees—usually those who work in a public school or at certain tax-exempt organizations.

A 403(b) plan can be a Roth or traditional account—also like a 401(k). With a Roth 403(b), your contributions will be taxed before you deposit them. Then your funds will grow and can be withdrawn tax-free as long as you’re 59 ½ or older and have owned your Roth account for at least five years. With a traditional 403(b), you’ll contribute pre-tax funds and be taxed when you make withdrawals.

Who can contribute to a 403(b)?

403(b) plans are typically made available to public school employees at K–12 schools and state colleges or universities, eligible church employees, employees at cooperative hospital service organizations, and employees at certain 501(c)(3) tax-exempt organizations.

Employers who offer a 403(b) need to follow the universal ability rule, which means that if they offer a 403(b) plan to one employee, they need to offer it to all qualifying employees. There are a few exceptions to this rule, however. You may not be able to participate in a 403(b) if:

• You are contributing less than $200 to your 403(b) on an annual basis.

• Your employer offers another retirement plan—like a 401(k)—that you are contributing to.

• You are a part-time employee who works fewer than 20 hours per week.

How does a 403(b) retirement plan work?

If your employer offers a 403(b) plan, you’ll have a few options for how you can contribute to the account. As an employee, you can ask your employer to withhold a portion of your paycheck to put into your 403(b) account—also known as making an elective deferral. Your employer can also make nonelective employer contributions, either matching your contributions or making additional discretionary contributions. Depending on whether you have a traditional 403(b) or a Roth 403(b), your contributions will be taxed before you deposit them (with a Roth account) or when you withdraw them (with a traditional account).

403(b) contribution limits for 2023

As with many retirement savings accounts, the IRS places limits on what you’re able to contribute to a 403(b) in any given year. (These limits are very similar to the annual 401(k) contribution limits.)

According to the IRS, in 2023, you’re able to contribute a maximum of $22,500 or 100 percent of your includable compensation (whichever is lower) to a 403(b). Employees aged 50 or older can also contribute an additional $7,500 in catch-up contributions. However, the limit to catch-up contributions would apply to any contribution made to a retirement account—including other plans you may contribute to. In 2023, the overall contribution limit (including both your contributions and employer contributions) for a 403(b) is $66,000 or the employee’s includable compensation for that year (whichever is smaller).

One perk of a 403(b) is that it rewards longevity with an employer. If you have a 403(b) and you’ve worked for a qualified organization for 15 years or more, you could be eligible to contribute an additional $3,000 per year for up to five years (provided you meet the plan requirements).

How are 403(b) assets invested?

One downside of a 403(b) is that you may have fewer options for investing funds compared to other retirement accounts. Options for investing 403(b) funds typically include an annuity contract or mutual funds, whereas other retirement accounts—like a 401(k)—may include more options.

Making withdrawals from a 403(b)

You’ll be eligible to begin making withdrawals from your 403(b) when you reach age 59½ (otherwise, you’d pay a 10 percent penalty on early withdrawals). However, you may be able to withdraw funds prior to turning 59½ if you become disabled or encounter financial hardship with no penalty. If you leave your employer and are no longer eligible to contribute to a 403(b), you could be eligible to move funds into another retirement account or leave funds in the 403(b) to grow.

Pros and cons of a 403(b) plan

A 403(b) plan has some perks that other retirement plans don’t, but there are some disadvantages to having one, too. Here are some advantages and disadvantages of a 403(b):

What are the advantages of a 403(b)?

Like a 401(k), a 403(b) can offer a tax-advantaged method of saving for retirement. Depending on the terms of the plan, a 403(b) can offer a few added opportunities to save, like the ability for employees who have worked with an organization for 15 years or more to make additional catch-up contributions. A 403(b) plan (depending on its terms) may also allow an employer to continue making contributions for up to five years after an employee has left.

Additionally, 403(b) plans typically have shorter vesting schedules, meaning that you wouldn’t have to wait as long for your employer’s contributions to be yours to keep. (Some even have immediate vesting.) And 403(b) plans may be eligible for transfer to other qualified plans. So, if you switch employers and decide you no longer want to contribute to your 403(b), you could transfer funds to another retirement plan (if your plans allow it).

A 403(b) can also provide some security by serving as another financial cushion. You may be able to take a loan out on your 403(b) before you begin making withdrawals, as long as you don’t withdraw more than 50 percent of your vested balance and repay the loan (plus interest) within five years.

What are the disadvantages of a 403(b)?

While 403(b) plans may have some additional perks, there are some limitations to these plans, too. Investment options for 403(b) plans are typically fewer than with other retirement accounts. (Typically, 403(b) funds can be invested only in an annuity or mutual funds.) Some 403(b) plans can also carry higher fees than other retirement options, so it’s important to understand the specifics of the plan before enrolling in one. Certain 403(b) plans also may not be subject to the Employee Retirement Income Security Act (ERISA), which can provide protection to you, the employee, by setting minimum standards for the account terms.

What is the difference between a 401(k) and a 403(b) plan?

In many ways, 401(k) plans and 403(b) plans are similar: both offer tax advantages when saving for retirement, both have similar contribution limits, both offer Roth or traditional accounts, and both have certain requirements for when you’re able to withdraw funds without penalty.

The main difference between a 401(k) and a 403(b) is who is eligible to contribute to them. A 403(b) plan is typically available only to employees of public or nonprofit organizations, whereas 401(k) plans are typically offered to employees in the private sector. 401(k) and 403(b) plans also vary in the types of investments offered. Many 401(k) plans offer more investment options, whereas 403(b) plans are typically limited to just annuities and mutual funds. Another notable difference is the additional contribution opportunities of a 403(b)—like potentially being able to contribute $3,000 more annually if you’ve been with an employer for 15 years or more.

How to invest in a 403(b)

If you are eligible to contribute to a 403(b), you’ll likely find information through your employer or a company that offers a 403(b). However, before starting any investment—including a 403(b)—you’ll want to understand how the investment fits into your overall financial picture. There are many ways to save for retirement, and while a 403(b) could be a great option, a 401(k), IRA or annuity could also be beneficial investments to include.

Consulting an advisor when developing a retirement plan can help you make decisions that work best for your situation. Start by discussing your retirement goals with a Northwestern Mutual financial advisor, who can audit all of your existing assets, make recommendations, and help you develop a plan that’ll allow you to live the life in retirement that you’ve always dreamed of.