What Are the Tax Implications of a 403(b) Account?

A 403(b) is a tax-advantaged retirement plan for employees of public schools and nonprofit organizations. Employees can make contributions from their paychecks and let the earnings grow tax-deferred until withdrawn in later years.

Understanding the tax implications of a 403(b) account can help you determine the best time to withdraw funds. The following guidelines can help.

Tax Implications of a Traditional or Roth 403(b)

Consider the tax implications when deciding whether to invest in a traditional 403(b), Roth 403(b), or both:

• If you expect your taxable income in retirement will likely be higher than while working, you might want to make more Roth contributions to pay taxes at a lower tax rate, reducing your overall tax burden.

• If you expect to withdraw less annually in retirement than you earned while working, contributions to a traditional Roth 403(b) might make more sense.

Aim to match your employer’s contribution in traditional (pre-tax) contributions, then contribute additional income as Roth (after-tax) contributions. For instance, if your employer offers a 6% match on 403(b) contributions, you could contribute 6% to your traditional 403(b) account and an additional 4% to your Roth 403(b) account, for a total contribution of 10% to your retirement accounts.

403(b) Accounts and Tax Deferral

Traditional 403(b)

A traditional 403(b) account is funded with pre-tax contributions:

• The earnings grow tax-deferred.

• The money is taxed as ordinary income upon withdrawal.

• You typically must start taking required minimum distributions (RMDs) when you reach age 73.

• If you are separated from service, you can begin withdrawing funds from your traditional 403(b) penalty-free at age 59 ½.

Roth 403(b)

A Roth 403(b) account is funded with after-tax contributions, and the money can be withdrawn tax-free during retirement if the account is held for 5 years.  

403(b) Accounts and Federal Income Tax Filings

Your employer reports your traditional 403(b) contributions on your W-2:

• You do not report your contributions on your federal tax return because the funds are tax-deferred.

• When you begin making withdrawals during retirement, your contributions and earnings will be reported as ordinary income.

• You must pay federal taxes on withdrawals.

403(b) Accounts and State Income Tax Filings

Your employer reports your traditional 403(b) contribuitons on your W-2:

• You do not report your contributions on your state tax return because the funds are tax-deferred.

• When you begin making withdrawals during retirement, your contributions and earnings will be reported as ordinary income.

• You must pay state taxes on withdrawals if you live in a state that collects state income tax.

403(b) Tax Penalty on Early Withdrawal

Withdrawing funds from your traditional 403(b) account before age 59 ½ typically results in a 10% early withdrawal penalty and income tax on the withdrawal. Conversely, withdrawing funds from your Roth 403(b) account before age 59 ½ typically results in a 10% early withdrawal penalty and income tax on the earnings withdrawn.

403(b) Taxes During Retirement

You’ll start paying federal and state income taxes on your traditional 403(b) contributions and earnings when you begin withdrawals during retirement. Because the withdrawals are taxed as ordinary income, any proceeds will be taxed at the standard rate. If you live in a state without state income tax, you won’t pay state taxes.

*This information is for educational purposes only.