# What Is a 403(b) Tax-Sheltered Annuity Plan?

![403(b) Plan](https://www.investopedia.com/thmb/8IxEv21gqZOSJuza19c7s89P-o0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/403bplan_final-67070c84b22b42478c5bb4c12792995c.png)

*— Investopedia / Michela Buttignol*

> **Definition**
>
> A 403(b) plan, also known as a Tax-Sheltered Annuity (TSA) plan, is a retirement savings account offered to employees of schools, the public sector, and non-profits.

## What Is a 403(b) Tax-Sheltered Annuity Plan?

A 403(b) tax-sheltered annuity plan (TSA) is a retirement savings plan for employees of public schools, government agencies, and certain other tax-exempt non-profit organizations.

Employees who are eligible to use a 403(b) include teachers, school administrators, professors, government employees, nurses, doctors, and librarians.

### Key Takeaways

*   The 403(b) Tax-Sheltered Annuity Plan (TSA) was designed for employees of tax-exempt organizations.
*   As with a 401(k), contributions to a 403(b) are made through payroll deductions and come with tax benefits for the saver.
*   Investment choices can be more limited in a 403(b) and some accounts offer less protection from creditors than 401(k)s.

## 403(b) Contributions

The 403(b) Tax-Sheltered Annuity Plan operates like a [401(k)](https://www.investopedia.com/articles/retirement/08/401k-info.asp) plan, allowing participants to save money for retirement through [payroll deductions](https://www.investopedia.com/terms/p/payroll-deduction-plan.asp) while enjoying certain tax benefits. Similarities include:

*   Contributions through payroll deductions
*   Annual contribution limits set by the [Internal Revenue Service](https://www.investopedia.com/terms/i/irs.asp) (IRS)
*   An option for the employer to match part of the employee's contribution
*   Participants must reach 59½ before withdrawing funds or face an [early withdrawal](https://www.investopedia.com/terms/e/earlywithdrawal.asp) penalty

Those who are eligible to contribute to a 403(b) include:

*   Employees of public schools, state colleges, and universities
*   Public school employees of Indian tribal governments
*   Ministers, members of the clergy, and church employees
*   Employees of other tax-exempt organizations

> **Important**
>
> If an employer offers a 403(b) and a 401(k), individuals can contribute to both, but their combined contribution cannot exceed the annual IRS limit of $23,500 in 2025 (up from $23,000 in 2024.) People aged 50 and over can contribute an additional $7,500 as a catch-up contribution, although some 403(b) plans base eligibility for the catch-up on length of service rather than age.

## Types of 403(b) Tax-Sheltered Annuity Plans

Like the 401(k), the 403(b) plan can give the employee a choice of a traditional plan or a Roth plan. Not all employers offer a Roth option.

With a traditional 403(b) plan, the employee has pretax money automatically deducted from each paycheck and paid into a personal retirement account. Thus, the employee's income and the taxes owed on it are reduced for the year. The taxes will be due only when the employee makes a withdrawal.

With a Roth 403(b) plan, [after-tax money](https://www.investopedia.com/terms/a/aftertaxincome.asp) is paid into the retirement account. There's no immediate tax advantage. But, the employee will not owe any more taxes on that money or the profit it accrues when it is withdrawn.  

> **Fast Fact**
>
> Clergy can participate in a 403(b) but another plan, the 403(b)(9), is designed specifically for employees of religious institutions.

## Advantages of 403(b) Plans

The big advantages of a 403(b) are the same as those for a 401(k): The money contributed and the earnings that accrue in a traditional account are tax-deferred until they are withdrawn. Both the contributions and the earnings in a Roth 403(b) are free from further taxes.

Many 403(b) plans vest funds over a shorter period than 401(k)s, and some even allow immediate [vesting](https://www.investopedia.com/terms/v/vesting.asp) of funds, which is rare for 401(k)s.

An employee with 15 or more years of service with certain nonprofits or government agencies may be able to make additional catch-up contributions to a 403(b) plan. The usual eligibility for the catchup starts at age 50.

> **Fast Fact**
>
> According to a 2024 survey by AARP of age 50-plus adults who are regularly saving for retirement, just 33% expect to accumulate enough money in retirement to be financially secure if they continue saving at their current rate.

## Disadvantages of 403(b) Plans

People who withdraw money from a 403(b) plan before age 59½ owe income taxes on the money in the year it is withdrawn, plus a 10% tax penalty. (The same rule applies to a 401(k) plan.)

The penalty can be avoided under certain circumstances, such as separating from an employer at age 55 or older, needing to pay a qualified medical expense, or becoming disabled. The taxes owed cannot be avoided.

When the 403(b) was invented in 1958, it was known as a [tax-sheltered annuity](https://www.investopedia.com/terms/t/taxshelteredannuity.asp). True to its history, the modern 403(b) offers the [variable annuity](https://www.investopedia.com/terms/v/variableannuity.asp) contract as an option.

Otherwise, a 403(b) tends to offer a more limited choice of mutual fund investments than its cousins in private business. plans. Many other investments, such as Individual stocks and [real estate investment trusts](https://www.investopedia.com/terms/r/reit.asp) (REITs), are prohibited.

Pros

*   Earnings and returns in regular 403(b) plans are tax-deferred until they are withdrawn
    
*   Many plans vest in short periods or even immediately
    
*   Generous eligibility for catch-up contributions based on length of service
    

Cons

*   Early withdrawals are subject to a 10% tax penalty
    
*   Narrower investment choices than similar plans
    
*   Accounts may lack full protection from creditors
    

## What Are the Similarities Between 401(k) and 403(b)?

The 401(k) and the 403(b) are both long-term retirement savings plans offered through employers. Both are [tax-advantaged](https://www.investopedia.com/terms/t/tax-advantaged.asp) ways for employees to save for retirement.

The 403(b) tends to offer a smaller choice of investments. At least one of those choices will be an annuity plan.

Some employers in the non-profit sector offer their employees both a 401(k) and a 403(b).

## When Is Money in a 403(b) Tax-Sheltered Annuity Plan Taxed?

The deferred salary is not subject to federal or state income tax until the money is distributed. A 403(b) plan may offer a Roth account as an option. In that case, contributions are taxed immediately but the entire balance is tax-free when it is withdrawn.

## What Types of Employers Can Establish a 403(b) Plan?

Public educational institutions and 501(c)(3) tax-exempt organizations are the only types of employers that may establish a 403(b) plan. 

## The Bottom Line

The 403(b) is offered by public schools and other tax-exempt organizations to many of their employees. It works just like a 401(k) plan offered by a company and may include contributions by employers. The IRS establishes limits to annual contributions to 403(b) plans, 401(k) plans, and IRAs.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Retirement Topics - Exceptions to Tax on Early Distributions](https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions)."
>     
> 2.  Internal Revenue Service. "[IRC 403(b) Tax-Sheltered Annuity Plans](https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans)."
>     
> 3.  Internal Revenue Service. "[401(k) limit increases to $23,500 for 2025, IRA limit remains $7,000](https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000)."
>     
> 4.  Internal Revenue Service. "[How Much Salary Can You Defer if You’re Eligible for More than One Retirement Plan?](https://www.irs.gov/retirement-plans/how-much-salary-can-you-defer-if-youre-eligible-for-more-than-one-retirement-plan)"
>     
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>     
> 6.  Internal Revenue Service. "[Retirement Topics - 403(b) Contribution Limits](https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-403b-contribution-limits)."
>     
> 7.  AARP. "[The Importance of Having a Plan for Retirement](https://www.aarp.org/content/dam/aarp/research/topics/work-finances-retirement/financial-security-retirement/financial-security-trends-january-2024-retirement-planning-50-plus.doi.10.26419-2fres.00525.047.pdf)."
>     
> 8.  Internal Revenue Service. "[Section 403(b) Tax-Sheltered Annuity Arrangements](https://www.irs.gov/pub/irs-tege/eotopici95.pdf)." Page 1.
>     
> 9.  Internal Revenue Service. "[Retirement Plan Investments FAQs](https://www.irs.gov/retirement-plans/retirement-plan-investments-faqs)."
>     
> 10.  Financial Industry Regulatory Authority. "[401(k) Basics](https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-basics)."
>      
> 11.  Internal Revenue Service. "[IRC 403(b) Tax-Sheltered Annuity Plans](https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans#:~:text=A%20403%28b%29%20plan%20%28tax%2Dsheltered%20annuity%20plan,their%20salary%20into%20individual%20accounts.)."