403(b)

A 403(b) is a tax-advantaged retirement plan offered by public schools, 501(c)(3) tax-exempt organizations, and certain religious employers to their employees. Named for the tax code section that authorizes it, a 403(b) functions much like its private-sector cousin, the 401(k): money comes out of your paycheck before or after tax, grows with a tax advantage, and is invested for retirement. The plan sponsor and investment menu look different, but the core mechanics — deferral limits, catch-up contributions, and the traditional-versus-Roth choice — largely mirror a 401(k).

Historically, 403(b) plans were restricted to two investment vehicles: annuity contracts from insurance companies (which is why 403(b)s are sometimes still called "tax-sheltered annuities") and custodial accounts invested in mutual funds. Many plans still offer only one or the other, so the fund menu — and its costs — can vary a lot more from employer to employer than a typical 401(k)'s. Annuity-based 403(b)s in particular can carry higher underlying fees than a comparable 401(k) invested in index funds, which is worth checking before assuming your employer's plan is the cheapest place to save.

Contribution limits track the 401(k)'s: employees can defer up to $24,500, with an $8,000 catch-up starting at age 50 and a temporary "super" catch-up of $11,250 for those aged 60 through 63. Beyond the standard age-50 catch-up, employees with 15 or more years of service at a qualifying organization — schools, hospitals, home health agencies, health and welfare service agencies, and churches — can be eligible for an additional catch-up under a separate, long-standing rule unique to 403(b)s, subject to its own lifetime cap. A person eligible for both this service-based catch-up and an age-based catch-up in the same year doesn't have to pick one over the other — the IRS applies the 15-year catch-up first, then any additional age-based catch-up room on top of it, so an eligible participant can potentially defer more than either provision would allow alone.

One structural point matters for how protected the money is: 403(b) plans sponsored by public school districts and by churches are generally exempt from ERISA, the federal law that otherwise governs private retirement plans. Many nonprofit-sponsored 403(b)s that include employer contributions or more active plan administration are ERISA-covered like a 401(k). Whether a plan is ERISA-covered affects creditor protection and certain plan-governance rules, though it rarely changes the tax treatment an employee experiences day to day.

A hypothetical example: Tom, 62, has worked at the same nonprofit hospital for 20 years and contributes to its 403(b). Because he's between 60 and 63, he can use the temporary super catch-up rather than the standard age-50 catch-up, letting him defer more than a younger coworker could in the same year. His hospital's plan also happens to qualify him for the long-service catch-up available to 403(b) participants with 15+ years at certain organizations — and because the two provisions stack rather than compete, his plan administrator applies his 15-year catch-up room first, then the super catch-up on top of that, letting him defer more than either provision would allow on its own.

Meanwhile his colleague Priya, 28, is just starting out and contributes a smaller percentage of pay into the same 403(b)'s Roth option, choosing to pay tax on her contributions now while her income — and tax bracket — are relatively low.

Pros

• Same high contribution limits as a 401(k), well above what an IRA alone allows.
• Payroll deduction makes saving automatic.
• Traditional and Roth options let you choose when you pay tax on the money.
• Long-tenured employees at qualifying organizations may access an additional catch-up contribution.

Cons

• Investment menus, especially annuity-based ones, can carry higher fees than a comparable 401(k) invested in low-cost index funds.
• Plan quality varies widely by employer, and not every 403(b) offers a matching contribution.
• Early withdrawals before 59 1/2 generally face the same 10% penalty and income tax that apply to a 401(k).
• Whether the plan is ERISA-covered depends on the sponsor, which affects creditor protection and plan governance.