403(b) Plans

Section 403(b) Plans (Tax-Deferred or Tax-Sheltered Annuity Plans)

What Is a Section 403(b) Plan?

There are two general types of 403(b) plans:

  • voluntary-only salary deferral or reduction plans in which employees allocate a portion of their pre-tax compensation to the 403(b) plan, generally not operated as part of ERISA, and
  • plans in which employers make contributions for eligible employees (employees may also make elective deferrals to these plans, which may be subject to ERISA).

Eligible Organizations

A Section 403(b) plan is a retirement plan available only to employees of:

public education organizations, and Section 501(c)(3) tax-exempt organizations.

Public Education Employees

Eligible public education employees generally include teachers, school administrators, and employees in other nonacademic staff positions. School board members are generally not eligible for a Section 403(b) plan.

Section 501(c)(3) Organizations

Section 501(c)(3) organizations are nonprofit, tax-exempt organizations. Examples include nonprofit hospitals; nonprofit nursing homes; private schools, colleges and universities; and certain other types of charitable organizations.

To qualify for 501(c)(3) tax-exempt status with the IRS, an organization must meet all of the following requirements at all times:

It must be organized and operated exclusively for one or more of the following purposes: charitable, religious, scientific, testing for public safety, literary, education, prevention of cruelty to children or animals, or to foster certain amateur sports competitions.

It must be for the good of the general public and not just for a selected group of persons.

It must not, as a substantial part of its activities, attempt to influence legislation or participate to any extent in a political campaign for or against any candidate for public office.

No part of its net earnings may benefit private shareholders or individuals.

Tax Advantages

Section 403(b) plans share the two basic tax advantages of all tax-qualified plans:

Contributions to the plan are excludable from the employee’s gross income, up to certain maximums, and earnings on funds accumulated in the plan are tax-deferred until taken as distributions.

Contributions to a 403(b) plan are not reported as current income and generally are not subject to current federal income tax.

Technically, the contributions are exclude-able from gross income rather than deductible, but the federal income tax effect is generally the same. Contributions to a 403(b) plan by means of a salary reduction agreement are still subject to FICA and Medicare tax withholding, however.

Earnings on 403(b) contributions are not currently taxed. Thus, they can accumulate on a tax-deferred basis until eventually taken as distributions.

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