What Is a 403(b) Plan?

403(b) PlanA 403(b) plan is a retirement plan for employees of public schools and other tax-exempt organizations. It's also called a tax-sheltered annuity (TSA), a tax-deferred annuity, or a 403(b) annuity.

Only certain people are eligible to participate in 403(b) plans: employees of public school systems and those who work for 501(c)(3) organizations.

A 403(b) plan has several tax advantages. Contributions are made pre-tax, so the employee has a reduced taxable income and the earnings on plan contributions are tax-deferred. After retirement, when the assets are distributed, the plan holder may be in a lower tax bracket. Also, it is possible to take loans from a 403(b) account. The money must be paid back, however, or significant tax penalties will result.

Just as in a 401(k) plan, employees can fund their retirement accounts with tax-free contributions and employers can also make contributions to employee accounts. Eligible employees are allowed to defer up to 100% of their salaries, if their yearly salary does not exceed $16,500 (in 2010). Employees 50 years old and older can make special "catch-up" contributions to their 403(b) of an additional $5,500 each year. Employers may also contribute to employee accounts, in an amount that is either discretionary or fixed. The total combined contributions of employee and employer may not exceed a fixed amount, however. The contribution limits are indexed annually for inflation, and vary from year to year. For example, in 2010, the combined employee and employer contributions to one individual's account could not exceed $49,000.

A 403(b) plan could be an annuity contract, such as one provided by an insurance company, a custodial account through a regulated investment company or a retirement income account, with the investment options being mutual funds or annuities. Employers may determine the choice of financial institutions, but employees have the option of choosing the type of investment from the employer's list of investment options.

As with other retirement plans, certain rules apply. When you reach age 59½, you can begin taking regular 403(b) withdrawals without penalty, although you will pay regular income taxes on the money you withdraw. Withdrawals made before age 59½ are subject to an additional 10% federal tax penalty unless a qualifying event occurs, such as death or disability. Once you reach age 70½, you must begin taking the annual required minimum distribution. The distribution schedule is calculated based on your life expectancy. You may also choose to collect your entire investment in one lump sum.

Contact your employer to find out more about your retirement plan options. Similar to a 401(k) plan offered to employees of corporations and businesses, a 403(b) can be an excellent retirement plan for employees of public schools and non-profit organizations

This article is not intended to be tax or legal advice, and the information in it may not be relied on for the purpose of avoiding federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.