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How Does a 403(b) Plan Work?

So you’re ready to save for retirement, but you don’t have a job working for corporate America. You work at a nonprofit or tax-exempt organization. We're talking to teachers, government employees, nurses, and doctors here, who spend their careers serving others.

After a long and fulfilling career of taking care of others, wouldn’t it be nice to enjoy the fruits of your labor? You’ve heard your company offers this thing called a 403(b) plan, but you’re not sure what it is or how it works. Well, it’s an employer-sponsored investment account that can help you reach your high-definition retirement dreams of spending time with family, enjoying your hobbies, or traveling.

But you need to get started now to have enough in retirement to fund those dreams. Don’t worry, we’ll walk through it together. It’s time to put your money to work, so you can Retire Inspired!

What Is a 403(b) Plan?

Simply put, a 403(b) is an employer-sponsored plan you can use to save for retirement, like a big bucket you put money into for your future. Then, when you retire, you draw your income from that bucket.

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Like the more well-known 401(k) plan, there are two main types of 403(b) plans—traditional or Roth—and the big difference between them is how they’re taxed.

  • Traditional 403(b): These retirement plans are funded with pre-tax dollars and the money inside grows on a tax-deferred basis. That just means you won’t pay taxes on the money now, but you’ll be taxed on the withdrawals you take out in retirement.
  • Roth 403(b): The word Roth gives us goosebumps because it means “tax-free!” If your employer offers this option, grab it with both hands! Since you’re contributing after-tax dollars, the money you put into a Roth 403(b) grows tax-free and you won’t pay any taxes when you take the money out in retirement. But hear us out: Only your contributions grow tax-free. If your company offers to match the money you put in (more on that in a minute), the money your company puts in grows tax-deferred, so you will have to pay taxes on the match side of the account down the road.   

How Does a 403(b) Plan Work?

You get to choose how much money you want to contribute to the plan, either a percentage of your salary or a set dollar amount, and that money will be taken out of your paycheck. And—bonus!—employers can contribute to your accounts as well (this is called matching). If your employer offers a match, you’ll want to invest at least that percentage in the 403(b) when you’re ready to start investing. People, it’s free money!

Now, a word of caution with the 403(b)—these plans can be loaded with insurance products like annuities with low returns, expensive fees and surrender charges. Steer clear of those and stick with good growth stock mutual funds!

Contribution Limits, Distributions and Penalties

Like other employer-sponsored plans, a 403(b) has contribution limits, early withdrawal penalties and tax implications. For 2021, the total contribution limit for a 403(b) is $19,500. But if you’re age 50 or older and need to catch up, you can put up to $26,000 into your account. In 2022, the contribution limit increases to $20,500 and if you're eligible for the catch up, you can put up to $27,000 in your 403(b). 1

If you make a withdrawal from your 403(b) before you’re 59 1/2, you’ll have to pay a 10% early withdrawal penalty. Plus, you’d be losing the growth potential of those dollars and stealing from your future self. Don’t do this!

Now, a distribution is when you take money out of your 403(b) plan penalty free. It doesn’t trigger the early withdrawal penalty because you are 59 1/2, or you’re rolling the money from one qualified plan to another.

One exception to the early withdrawal penalty applies if you’re a member of the reserves. If you’re called to active duty for 179 days or more (thank you for your service!), you may be eligible for a qualified reservist distribution, in which case the IRS 10% penalty won’t apply, but the distribution is still taxable. But just because you can do it doesn’t mean you should.2 Remember, you want to leave your retirement investments alone so they can keep compounding and growing!

What’s the Difference Between a 401(k) and 403(b)?

As you’ve probably figured out by now, the basic difference between these two plans is the types of employees eligible to participate. A 403(b) is only offered to nonprofit, religious, school district and governmental organization workers. Beyond that, there are some other key differences.

Benefits of a 403(b)

  • Vesting. Many 403(b) plans vest funds in a short period of time. (Vesting is a fancy way of saying the money is all yours!) Some have immediate vesting, so the money is yours from day one.
  • 15-year rule. In 403(b) plans, employees with at least 15 years of service can add an extra $3,000 to their 403(b)s each year (more on this in a minute). This is above and beyond the $20,500 annual limit for 2022.

We know, there’s a lot here! Let’s look at a quick example. Say Sally is 50 years old, making a $70,000 salary, and has taught in her school district for more than 15 years. For most of her teaching career, Sally only contributed $2,500 a year to her 403(b). When she hit her 50s, she realized she had some major catching up to do. In this case, Sally’s contributions break down like this in 2022:

Contribution Type

Contribution Limit

Annual Limit


15-Year Service Rule

$ 3,000

Elective Deferral and School District Match


Over 50 Catch-Up

$ 6,500



So this means Sally can put close to half her salary in tax-advantaged retirement accounts—that’s awesome! Her employer pitches in even more and brings her total above the $57,000 annual contribution limit. But the IRS is cool with it and lets her use catch-up contributions and the 15-year rule. Sally’s got a real shot at building a decent nest egg, despite getting a late start.

Work With a Pro

If you’re an educator or nonprofit worker, a 403(b) plan can be a great base for your retire-inspired dreams if it offers solid mutual fund choices. No matter where you work or what you earn, with planning and a little guidance, you can reach your retirement dreams. In fact, in our study of more than 10,000 millionaires, 79% of them reached millionaire status through their employer-sponsored retirement plan, and when we asked them what they did for a living, teaching was in the top three professions. You can do this!

Don’t try to do it alone though. Get with an investing professional like a SmartVestor Pro today, who can walk you through your options. You’re not finished, so stay focused!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

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