What is a 403b?

A 403b is a U.S. tax-deferred retirement plan available to public education, non-profit and cooperative hospital service employees, and self-employed ministers. Through an agreement with their employers, people can defer a portion of their salaries into the retirement account through payroll deductions on a pre-tax basis. They choose among vendors offered by their employers to determine where they would like these dollars invested; options include annuities and mutual funds. Both employee contributions and earnings from investments are allowed to grow, tax-deferred, until either the money is withdrawn from the 403b account or until the time of retirement.

Established by the U.S. government in 1958, the 403b retirement plan was intended to encourage employees of tax-exempt organizations to put aside money and to invest for their retirement. Participants in 403b retirement accounts are employees of organizations determined tax-exempt under Section 501(c)(3) of the Internal Revenue Code, or what are generally called 501(c)(3) organizations. This includes, for example, schoolteachers, school administrators, professors, nurses, doctors and ministers. Although many 501(c)(3) employees receive pensions when they retire, they are generally less than their salaries. Money saved and earned through this type of retirement savings can supplement employee pensions and other retirement savings.

Employees' 403b contributions, which are called elective deferrals, are pre-tax, so people who participate in this type of retirement savings plan also have lower tax bills. This tax reduction depends on the employee’s tax bracket and is calculated for each $1 US Dollar (USD) contributed. For example, a person in the 15 percent tax bracket whose elective deferral is $100 USD will decrease his federal income taxes by $15 USD, meaning his $100 USD contribution only costs $85 USD. Tax savings increase as contributions increase. In addition, low-income savers can receive a tax credit of up to 50 percent on up to $2,000 USD in elective deferrals.

The Internal Revenue Service (IRS) determines the annual maximum of both an employee's elective deferral and the amount by which his employer can contribute to his 403b savings plan through a company match. If his retirement plan permits, an employee may qualify to increase his annual elective deferral if he has at least 15 years of service. An employee who is age 50 or older by the end of the calendar year may also be eligible to make catch-up contributions to his savings account if his plan permits.

Any 403b withdrawals before age 59.5 are subject to a 10 percent tax penalty as well as the normal tax fees associated with retirement account withdrawals. This 10 percent penalty may be waived under certain circumstances, such as separating from an employer in either the year or the year after which a person reaches age 55, a qualified medical expense or extreme financial hardship. Money can be borrowed from the savings plan if an employer permits loans, but only in amounts in accordance with IRS regulations and with specific repayment rules. In general, 403b funds must be withdrawn no later than April 1 of the year following the year in which a person reaches age 70.5; if he is still working, he may defer this withdrawal until April 1 of the year after which he retires.