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

During my time as a licensed financial coach, I started my freelance writing business. I taught myself to write grant proposals, volunteered with local nonprofit organizations to gain experience, and secured contract work after a year.

Many of the nonprofit organizations I contracted with offered a 403(b) plan for employees. Although I was ineligible as an independent contractor, and I had other retirement plan options elsewhere, I was glad that the employees had access to these plans.

What Is a 403(b) Plan?

A 403(b) is a retirement plan available for employees in public schools, charitable 501(c)(3) tax-exempt organizations, and certain faith-based organizations. This type of plan is often included in benefits packages to strengthen employee attraction and retention.

How does a 403(b) Plan Work?

A 403(b) plan lets employees invest money from their paychecks into retirement accounts. Each employee decides how their money, along with any employer contributions, is invested in mutual funds, annuities, and other assets.

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

The type of 403(b) account an employee has impacts their tax benefits:

Traditional 403(b)

An employee can contribute pre-tax dollars from their paycheck to a traditional 403(b). The contributions and earnings grow tax-deferred until withdrawal in retirement.

Roth 403(b)

An employee can contribute after-tax dollars to a traditional 403(b). The earnings and distributions are federally tax-free if the account is held at least 5 years and the employee reaches age 59 ½, becomes disabled, or passes away, leaving the account to a beneficiary.

What Are the Advantages of a 403(b) Account?

Investing in a 403(b) account offers the following benefits:

• Automation: Employees can set a specific amount to be automatically transferred from each paycheck or a bank account to be invested in their 403(b) account, simplifying retirement savings.

• Employer contributions: Some employers contribute a set amount or match what an employee invests in their 403(b) account, such as $1 from the employer for every $1 the employee contributes. Employees are encouraged to maximize their annual contributions to increase the funds in their accounts and help reach their retirement goals.

• Compound interest: Compounding occurs when an investment earns interest on interest. Increasing the amount of money in the account helps provide financial security during retirement.

What Are the Contribution Limits for a 403(b) Account?

The contribution limits for a 403(b) account can annually change. The following limits are for 2025:

• Employees up to age 49 can contribute up to $23,500.

• Combined employee and employer contributions can be up to $70,000.

• If their plan allows, employees aged 50 to 59 or 64 and older are eligible for an additional $7,500 in catch-up contributions, increasing the employee contribution limit to $31,000.

• If their plan allows, employees aged 60 to 63 are eligible for catch-up contributions up to $11,250, increasing the employee contribution limit to $34,750.

• Employees are encouraged to check with the plan sponsor to see if the catch-up contributions are available to them.

If the 403(b) plan allows, employees who have spent at least 15 years working for the employer can contribute an additional $15,000 to their account:

• The contributions can be up to $3,000 over different years.

• The amount an employee can contribute annually might be reduced based on their prior contributions to employer-sponsored plans.

• For instance, an employee who contributed $75,000 or more to employer-sponsored retirement plans over the past 15 years would not be eligible to make additional contributions.

• Employees are encouraged to talk with the plan sponsor to determine how much they can save annually.  

What Are the Withdrawal Rules for a 403(b) Account?

The withdrawal rules for a 403(b) account include the following:

• Withdrawals before age 59 ½ incur a 10% penalty.

• Most withdrawals from a traditional 403(b) are taxable.

• Withdrawals from a Roth 403(b) are tax-free after the account is held for 5 years and the employee reaches age 59 ½.

If a 403(b) plan allows employees to take out a loan from their account, they should be mindful of the following:

• The loan plus interest must be paid back.

• Reducing the amount in the account lowers the impact of compound interest, potentially affecting the employee’s retirement savings goals.

• Depending on the plan’s guidelines, an employee who loses their job or changes employers must repay the loan by the time they file taxes for the year in which the job change occurs.

• If the loan is not repaid on time, it’s considered a withdrawal, potentially resulting in the employee owing taxes and a 10% penalty.

What Are the Required Minimum Distributions for a 403(b) Account?

A traditional 403(b) account has required minimum distributions (RMDs) starting at age 73 or 75, depending on the plan. However, employees still working for the organization can delay withdrawals until retirement:

• The IRS determines an RMD based on the employee’s account balance and life expectancy.

• If an employee made contributions before 1987 and the 403(b) plan separately accounted for the amounts, the contributions do not need to be included in the RMD calculations until the year the employee turns 75 or April 1^st of the year after they retire, whichever is later.

• The earnings and gains related to pre-1987 contributions are included in RMD calculations from the beginning.

• Employees who don’t take the RMD can end up owing 25% of the amount not withdrawn in penalties, in addition to potential taxes on the amount withdrawn in the future.

Conversely, a Roth 403(b) account has no RMDs. The money can remain in the account for as long as desired and be left to a beneficiary.

*This information is for educational purposes only.