A 403b is a specific type of retirement savings account that's funded by employee contributions and sometimes with matching employer contributions as well. These plans are offered by tax exempt organizations like churches, schools, and charities to their employees. As the years go by, the limits of annual contributions get adjusted, but they are much higher than for many IRA type investments. And older workers are allowed to make catch up contributions to their 403b to help them make up for lost time in cases where they didn't put enough away when they were younger (and who among us can really say we put enough away back then?).

Employee Retirement Account

A 403b is essentially an employee account because the money in the account belongs to the employee. One great feature, though, about these funds is that employers can make large contributions. In fact, the limits for employer contributions are much larger than they are for employee contributions to 403b accounts. As soon as any money hits these funds, it becomes the property of the employee right away. It is not like some programs where the employer's contributions are only vested after the employee has been with the company a certain number of years. This is a huge advantage for employees of non profits, because these funds are a great investment vehicle allowing them to pile up money in a hurry. All the money that goes into these accounts is tax exempt on the way in. It is allowed to grow tax free, and is treated as ordinary income and taxes as such upon withdrawal.

403b and 401k Plans

403b plans are not qualified plans under the terms of the U.S. tax code. They fall under a different category called tax sheltered annuity arrangements. The only organizations that are allowed to offer them are tax exempt ones like churches, schools and charities. Those in charge of these funds can only invest in annuities or mutual funds. So these 403b plans are similar to 401k plans, although there are some significant differences between the two as well.

For example, the top heavy rules that apply to 401k plans don't apply to 403b accounts. Employer contributions to the plans are exempt from taxable income only to the extent to which they fit under the employee's exclusion allowance. When the employee and the employer's total contributions exceed this allowance, all additional contributions must be shown as income on the employee's schedule 1040. There is a specific formula to determine that allowance, and it has to do with the number of year the employee has been with the nonprofit as well as some other factors.

Any contributions that are made to a custodial account which are invested in mutual funds are subject to an excise tax at the rate of six percent only on the amount by which they exceed the limit for maximum excludable contributions. There are penalties for early withdrawal of funds in these accounts, just as there are with 401k funds. As of the year 2002, employees were allowed to participate in both a 403b and a 457b at the same timer. Some employers offer both plans, so this makes for some complex taxable contribution calculations. Recent changes in the tax code have made 401k plans available to nonprofits, making 403b plans less popular in some cases. But the 403b is still an attractive choice for its ability to give employees and employers a vehicle to contribute large amounts of money in a tax advantaged way. These plans are worth participating in, especially if your employer is willing to contribute.

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