what is a 403b, 403(b) 403b retirement plan, 403b vs 401k

The Ultimate Guide To The 403b Retirement Plan


What is a 403b?

This year, many new teachers, nurses, and nonprofit workers across the country will walk into work on their first day and be greeted with paperwork asking them to “establish a 403b”. For many, this will be the first time they encounter one of the more obscure retirement accounts available. They might even say “what the heck is a 403b?”. The 403(b) is essentially an account, like the one at your bank, that holds investments instead of cash.

These accounts are reserved for certain employees of schools, hospitals, and other nonprofit organizations with few exceptions. In this guide, we will discuss what a 403(b) is, who uses these accounts, how to manage, and eventually distribute assets from them, and important rules to keep in mind for 403(b) participants.

what is a 403b

When most people think about retirement savings at work, they immediately think “401(k)”. While this is certainly the most common type of work sponsored retirement plan, many people are surprised to learn it wasn’t the first. Before the 401(k) there was the 403(b) and, although somewhat uncommon, many of these 403(b) accounts are still being funded and used for people across the country today.

Retirement Accounts 101

retirement accounts

Before getting into rules and regulations its important to understand the context surrounding the 403(b). The 403(b) is an investment account that falls into a larger category known as “retirement accounts”. Retirement accounts are exactly what they sound like, they are places you can put investments like stocks, bonds, and mutual funds and allow them to grow so that the account holder can build some long-term savings for themselves in retirement. 401(k)’s, IRA’s, deferred compensation, 403(b)’s and a few others are examples of retirement accounts that most people are familiar with. These accounts are different from your average brokerage investment account because they have been created and standardized specially by the federal government to help encourage people to take advantage of saving for their retirement.

One of the most important ways that the federal government does this is by allowing accounts designated as “retirement” accounts to enjoy something called tax deferral. In a non-retirement investment account, when an investor sees gains from his investments, he or she must pay taxes on those gains. By allowing an investor to avoid those annual taxes, you allow next years return to be based on a higher account value, over time these savings compound and lead to significant growth over normal taxed accounts. In return for this benefit, the federal government creates some rules about how and when an investor can access funds in their retirement account. We will dive further into tax deferral in another section, but it is important to understand the basic features that separate “retirement accounts” apart from the rest.

403(b) History

While it may seem like a standard aspect of getting a job today in American, there was a time when getting a job did not entitle you to one of these retirement accounts. In the days before the federal government enshrined “retirement accounts” into the tax code as special places for workers to grow their nest eggs, employers and employees were free to enter into mostly any agreement they saw fit. For many teachers, nurses, and other charitable workers across the country, that meant having their employers purchase them annuities over their career. These annuities were not funded by the employee and were essentially a pension fund that was owned by the employee. This is why, today, the 403(b) is also referred to as a “tax-sheltered annuity”.

In 1958, the Federal government added rule 403(b) to the tax code standardizing rules for employers who were offering these annuities to their workers. Rule 403(b) essentially creates that “tax-sheltered” aspect of the account and allowed the owners of these annuities to not only hold their annuity contracts but actually created a new type of account that allowed workers to accumulate and invest funds on a tax-deferred basis in annuities or any other kind of investment.

What is an Annuity

what are annuities

For some people, the annuity component of the 403(b) can be confusing, so it’s important to note that while these accounts were formed originally to set rules for annuities, in today’s 403(b) you are able to hold either an annuity or investments that you would typically find in a 401(k) or other work-sponsored plans. For the sake of simplicity, we won’t dive too deeply into annuities, as it is a broad and complicated family of products, but it’s important to understand their basic characteristics.

Types of Annuities

Annuities come in several different varieties. Very simply, an annuity is a contract between an insurance company and an individual. While some annuities, known as fixed annuities, offer a small guaranteed rate of return on any money held in the annuity, other contracts allow funds within the annuity to be invested in the stock market. These are known as variable annuities and, typically, when we discuss 403(b) accounts, these are the types of annuities that are being discussed.

A variable annuity functions a lot like an investment account. An individual adds a lump sum of money to their contract or pays in installments towards their account over time. The funds inside the annuity are invested in what are known as “sub accounts” these sub accounts function just like stock market-based investments. The annuities owner can select aggressive growth sub-accounts, sub-accounts designed to preserve value, and everything in between according to their preference.

Annuities vs other investment accounts

While that may sound like any other investment account, annuities have one big difference. Most of these products are designed for income, not investment. When the annuity owner chooses, he or she can “annuitize” their account. What this essentially means is that they cash in the value of their account and give all the money back to the insurance company. In return, the insurance company agrees to pay the annuitant a specified income, each month, either for the lifetime of the owner or a specific period of years.

For many people, having an account worth $500,000, for example, is less important than having a guaranteed, risk-free lifetime income of $2,500 per month. After all, the reason most people invest in retirement accounts stems from their need for income later in life. For individuals who do not want to manage their accounts and play a hands-on roll in paying themselves out of their accounts, an annuity can be a very attractive option.

How a 403(b) Works

Now that we understand how annuities work, we can look more deeply at how they work within the 403(b). As we discussed earlier, the 403(b) functions a lot like a 401(k). For those unfamiliar with the 401(k) it goes something like this. Employees can choose to defer up to $19,000 of their salary into their 403(b) each year. Employees who are over 50 years old can contribute the $19,000 limit plus an additional $6,000 in “catch up” contributions bringing their limit to $25,000 annually. The word “deferral” is important because what this allows the employee to do is not pay income tax on those contributions. An employee who makes $100,000 per year who chooses to max out deferrals to their 403(b) will add $19,000 to their retirement account and will pay taxes on $81,000 of income that year.

403(b) investment options

Once funds have been added to the account the account owner has a few decisions to make. The purpose of these plans is to create a tax-sheltered place for workers to grow their nest egg. Once you have funded your account you have the option to invest funds in a few different ways. While technically you could leave your funds in cash in your 403(b), most people choose to purchase investments with those funds in hopes that they will see some rate of return.

Who qualifies for a 403(b)

So, if these account features seem attractive to you, you are probably wondering how you can get started. The 403(b) is only open to a select set of professions. Fortunately, most employers offer retirement plans of some kind, and most of them behave the same way. For the most part, the 403(b) is utilized by schools, hospitals, and non-profit organizations. According to the IRS website, eligible employees are those who are:

  • Employees of tax-exempt organizations established under IRC Section 501(c)(3).
  • Employees of public school systems who are involved in the day-to-day operations of a school.
  • Employees of cooperative hospital service organizations.
  • Civilian faculty and staff of the Uniformed Services University of the Health Sciences (USUHS).
  • Employees of public school systems organized by Indian tribal governments.
  • Certain ministers if they are:
    • Ministers employed by Section 501(c)(3) organizations.
    • Self-employed ministers. A self-employed minister is treated as employed by a tax-exempt organization that is a qualified employer.
    • Ministers (chaplains) who meet both of the following requirements.
      • They are employed by organizations that are not Section 501(c)(3) organizations.
      • They function as ministers in their day-to-day professional responsibilities with their employers.

The bad news is, if you do not fall into one of these categories you will not be able to contribute to a 403(b). The good news is that you more than likely do qualify for an equivalent account such as a 401(k). As you read through this guide you will find that, for all intents and purposes, it is simple to just think of the 403(b) as the non-profit, hospital and school equivalent of the 401(k).

Getting started with a 403(b)

Let’s assume that you do fall into one of the categories mentioned above and you would like to start contributing to your very own 403(b). This process is typically handled for the employee and an account will usually be established as soon as you begin working, or when you attain a certain time requirement. Some organizations require that you must be working with them for 6 months or 1 year before you are eligible to participate in the company’s 403(b). Once you have satisfied their requirements, you will usually be given paperwork by your HR department to establish your account.

Funding Your Account

how to fund your 403b

There are essentially 2 important decisions that you will need to make once your account has been opened. How much would you like to put in? And, how would you like that money to be managed, or invested? The first of these decisions is rather easy. Unlike many other types of investment accounts where the owner must write a check or authorize a wire transfer to get funds in, work-sponsored retirement plans are funded through salary deferrals. On the paperwork you will be given to begin participating in the plan, you will be asked how much of your salary you would like to send to your 403(b).

This literally means that you will be diverting some of your paychecks into the account, and that’s important for two reasons. Firstly, most people adjust their standard of living to their paycheck. Once you set your salary deferral it’s easy to forget that the money is even yours to make decisions on and this feature encourages long term “set and forget” savings. The second benefit to this funding method is tax deferral. Not only on gains while the account grows, but believe it or not, tax deferral extends to your contributions to the account.

Tax Deferral

Let’s say a recent graduate accepts a position at a hospital and is set up with a 403(b). Salary (and tax) deferral means that, if this person earns $75,000 per year, but contributes $10,000 to their 403(b), they will only show $65,000 of income on their taxes for that year. Whatever you decide to defer to your 403(b) is not counted as income and is therefore not taxed. This is beneficial as your tax bracket can influence other things like your capital gains tax rate and is used when calculating many benefits. Although this side of tax deferral is nice, there is another, even more, beneficial use for the tax-deferred nature of these accounts.

Like all retirement accounts, the 403(b) allows funds inside to appreciate without tax until withdrawal. What this means for investors is that the account’s value can compound faster and faster as $20 saved in taxes grows to $40 and then $60. To illustrate this point we will use an example.

The “taxed” column represents a normal taxed account, each year as the investments produce income and dividends, those cash flows are taxed chipping away at the growth potential. In the “tax-deferred” column we see a retirement account where gains in the account are left to compound until they are taxed at withdrawal.

In the “taxed” column, you are seeing a 10% annual rate of return, after each year a 25% tax is assessed on gains in the account. In the final row, we remove $25,000 to tax our original $100,000 balance at 25% as well and we are left with nearly $800,000. This isn’t too bad, but it starts to seem a little underwhelming when compared to the nearly 1.2 million that tax deferral allowed you to accumulate over that same span of time.

Here’s a visual example of the same concept. The trick here is compounding. Warren Buffet said that man’s greatest invention was compound interest and here’s why. Just by leaving in an extra 25% of the gain, the tax-deferred account sees much faster growth as next years rate of return is based on the accumulated gains in the account each year. Although you still need to pay 25% in the end, the increased earning power on the way up pays. 

Managing Your 403(b)

After you have established your account, and have begun to add funds with salary deferrals, the real fun begins. Now its time to look into managing the account. In finance, managing your account refers to selecting investments, watching carefully as the things inside increase or decrease in value, evaluating fees, and rebalancing when needed. This may seem like a daunting task but there are many resources at your disposal if you’re willing to do a little extra work.

Outside company oversight

Firstly, it’s important to note that no matter where you work, your 403(b) is “managed” by a third party. Companies like Fidelity, Valic, Axa, and many other financial services firms offer service to these accounts, and your employer will have a relationship with at least one of them. What this means is that, if you’re 403(b) is managed by Axa, you will have access to an Axa advisor as well as their tools to help you with any questions you may have. You will likely receive a login for an online platform where you can view your investments and make changes as well as ask questions. When getting started this is usually a good place to begin.

One thing to bear in mind while working with these financial firms is that they may have an incentive to convince you to hold certain products in your 403(b). While this is not a bad business practice on its own, as Axa advisors typically have a comfort level and expertise with Axa products, you may find a situation where a financial rep is for some reason over eager to sell you their companies annuity in your account. In an effort to equip you for this conversation lets discuss some investing basics.

Investment basics

Investment basics

When you first add funds to your 403(b), they will be held in what as known as a “money market fund”. These funds function essentially like cash and are not designed to appreciate, but simply maintain their current value. They are very low risk, and for that reason offer a very low reward. If you’d like to see your money start growing, you’ll need to begin investing. What type of investments you select has to do with many factors like your level of experience, the amount of risk you are comfortable with as well as your time horizon. Time horizon refers to the length of time that an investor has until he plans to use the funds from his investment.

Generally, a longer time horizon usually means that an investor can take more risk. If you plan to use the funds you are investing within a few months, it probably isn’t a good idea to buy something that is highly volatile as you may find that they have lost a large portion of their value when you go to access them. Alternatively, someone who won’t need the funds for several decades has plenty of time to recoup losses and can afford to be a little riskier.

Risk and Reward

This concept of risk and reward is essential to understand in investing and goes something like this. The higher your chances of making lots of money on an investment, the greater chance there is that you could also lose the money. Think high risk, high reward, low risk, low reward. This makes sense, markets reward individuals who take long-shot bets and risk their investment.

Risk Tolerance

It is important before you begin investing, to identify your “risk tolerance”. This is the degree to which your personality and circumstances allow you to take a risk. A soon to be a retiree who prefers to be safe will invest very differently from a recent grad who loves to take risks. It’s impossible to start selecting investments until you identify where you are on that scale.

Credit Investopedia

When it comes to selecting these investments, one of the drawbacks to a work-sponsored plan like a 401(k) or 403(b) is that your employer will select your investment options for you. Rather than allow you to invest in anything you would like, your employer will work with the plan’s provider (Fidelity, Axa, Valic) to select 20+ “funds” for their employees to invest in. This helps reduce confusion and increase the uniformity of the plan for management purposes.

About Managed Investment Funds

A fund is a pool of investments that is managed by a professional investment advisor. Funds seek to provide returns like stocks, but without the risk of investing in a single stock. For example, if an investor likes technology companies, he or she can choose to buy stock in Facebook, OR a fund that invests in technology firms. Let’s say that bad news breaks about Facebook, the investor who holds the company stock will be in for a wild ride as the price of his investments reacts to the bad news. An investor who owns a technology fund, however, can rest easy, their fund owns Facebook, but it also owns 75 other technology companies. When an investor buys shares of a fund, he or she is technically purchasing a portfolio of companies selected by a professional that is managed over time.

Annuities in 403(b)

Due to the history of the 403(b), getting its roots from tax-sheltered annuities, it is very common to see not only “funds” on offer but annuities as well. This is one of the unique features of the 403(b), as annuities being held in 401(k)’s and other investment vehicles are fairly rare. Annuities come in many shapes and sizes, remember from above that they too invest in “sub accounts” which are essentially funds but with one key difference.

The annuity can be “annuitized” or exchanged for lifetime income at a time of the owners choosing. Couple this with the fact that many annuities offer what is known as a “return of premium” feature which is can be attractive to some investors.

Annuities vs mutual funds and stock

When you invest in a mutual fund or a stock, you are bearing the risk that those companies or funds that you have selected could fail. Although very rare, theoretically, your mutual fund could go to 0 and leave you out all the money that you put in. Annuities with “return of premium” features offer clients protection in that an investor can invest through sub-accounts, but in the event that their account goes to 0, they can recoup all their contributions to the account. Note that their gains are not protected. If an investor adds $100,000 to their annuity over their working life, and it grows to $350,000, then down to $0, they are only entitled to $100,000. Still, a nice benefit.


Before you run out the door and begin looking for annuities, be warned that there is always a tradeoff in investing. If you like some of the guarantees that owning an annuity can provide you better be willing to pay for them. It’s here that we will get into a discussion on fees that may be slightly complex but important none the less. In the world of investing there are several different types of fees that an investor pays. We will focus on mutual funds vs. annuities in this example (because most 403(b) plans will prohibit you from purchasing individual securities like stocks) and compare the fees for each so that you can make an educated decision.

The 3 Types of Fees

When it comes to mutual funds there are essentially 3 fees that you pay as the client. First, you pay the upfront sales charge. In order to “buy-in” to a mutual fund, these companies, and the salesperson who helps you charge an upfront commission for their services. This usually ranges from 3-6% of your initial purchase. This means that if you add $100 to the XYZ fund, $5 is charged as a fee, and $95 makes its way into your account. From there you will also pay what is known as a “12b-1” fee as well as a “management” fee.

“12b-1” refers to the section of the SEC rules that govern fees charged for marketing and distribution. 12b-1 fees essentially pay the marketing department and the people who print out and distribute sales materials for the fund. Management fees are more straight forward and usually compensate the people who are choosing the investments inside of your fund.

While the up-front charge is assessed only on new money going in, the 12b-1 fee as well as the management fee is calculated annually and assessed on the entire value of your account. The term “expense ratio” refers to the annual percentage of a fund that is taken out in fees each year and combines management fees with 12b-1 and other administrative fees. A mutual fund that holds $1,000,000 in securities with an expense ratio of 1% pulls $10,000 (1% of 1,000,000) in cash each year out of the fund to pay its manager and other workers. Average costs vary quite a bit but most funds land somewhere in the range of 0.8% to 1.5% when it comes to expense ratios.

As you can see from the chart above, before investing in anything it is very important that you understand the fees associated with the investment. Allways explore lower-cost options, but bear in mind that you often get what you pay for. Cheap funds with low expense ratios delegate lots of work to computers and cut corners where they can, high expense ratio funds might use more complicated strategies and may have larger teams overseeing them, so weigh cost and benefit before deciding.

Now let’s look at annuities without new education surrounding fees. As was mentioned above, the guarantees associated with an annuity are costly and here’s how that works. When you purchase an annuity, there are fees IN ADDITION to all those mentioned above (sub-accounts work just like mutual funds in terms of fees).

Not only are you on the hook for all the normal investment fees that you might pay, but annuities also charge what is known as a “mortality and expense” fee which averages another 1%-1.5% every year, on the total value of your account. Annuities also typically come with an annual administration fee (usually a round dollar amount like $40 per year) as well as additional fees for other riders and add-ons that you may decide to tack on to your annuity contract.

Whether or not the high fees of annuities seem appealing to you for the benefits they provide is up to each individual, some love their annuities and some not so much. Regardless of what you decide, it is important to consult with a financial professional and make sure that you ask all the necessary questions surrounding fees. Annuity sales typically compensate their salesman better than the same dollar amount going into mutual funds so be wary of a financial advisor pushing you to choose one thing over the other.

Accessing Your 403(b) in Retirement

We’ve covered some of the rules regarding your 403(b), we’ve discussed opening your account, as well as managing it, now its time for the fun part. Accessing your money in retirement (hopefully). For many, their road to retirement is riddled with bumps and setbacks, and occasionally it can be difficult to make ends meet. Unfortunately, your 403(b) is designed for retirement. Anyone who is looking to withdraw funds from there account before they reach retirement age (59 ½) they will have a 10% penalty assessed on any withdrawals from the account ON TOP OF the taxes that are owed upon withdrawal.

Rules for withdrawal pre-59 ½

There are few qualifying exceptions such as first-time home purchase, qualified educational expenses, or medical bills, but for the most part, accessing any 403(b) assets pre 59 ½ will trigger a penalty. Ask your HR department if you qualify for an exemption or work with a financial professional to determine if a withdrawal is in your best interest.

Rules for withdrawal post 59 ½

That aside, for those who have successfully made it to retirement, the 403(b) is fairly straight forward. Once you have reached 59 ½ and are retired (some organizations will also allow you to do what is called an in-service withdrawal if you are still working) you may access the account at your discretion.

One thing to keep in mind is that you are responsible for paying income tax on anything that you withdraw from the account (remember we deferred those taxes). This means that if $100,000 is pulled out of your account at once for a home purchase, you will need to cut a check to Uncle Sam for a certain % of that depending on your income level.


rmd's 403bs

One other thing to keep in mind is the required minimum distribution requirements. The 403(b), like the 401(k), traditional IRA, and other qualified assets carry a distribution requirement. This means that, if there are still funds in the account in the year that you turn 70, you must begin to take mandatory minimums out of your account each year. The government was nice to you all these years letting the funds grow tax-deferred, but now they want their share. In the calendar year that you turn 70 ½, you must withdraw a set amount of money from your accounts. Those who fail to do so will pay a 50% penalty to the IRS in that year, ouch!


To tie all of this together, the 403(b) is a retirement account much like the more traditional 401(k) and traditional IRA. When used properly it should be a place where teachers, nurses, non-profit workers, and ex-military members can build and grow a nest egg for retirement. When used as intended this powerful tool should allow you to set aside and invest enough to allow for an early retirement filled with more of the things that you want to do. If you’d like more information on the 403(b) contact your financial professional, it’s always important to seek out professional guidance before making any big money decisions.

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