403(b) Plans for Teachers and Nonprofit Workers

Most people who work in education, healthcare, or the nonprofit sector have heard of the 403(b) but may not fully understand what makes it different from the more widely discussed 401(k). The short answer is: quite a lot, depending on who runs your plan and what products are inside it.

The 403(b) was created by Congress specifically for employees of public schools, hospitals, churches, and other tax-exempt organizations under Section 501(c)(3) of the Internal Revenue Code. For decades, these plans were dominated by insurance company products, which means annuities, with fees that could quietly eat into your returns over a long career. That landscape has evolved, but the legacy still shows up inside many plans today.

This guide walks through how a 403(b) actually works, where it differs from a 401(k), what to look for in your investment menu, how the less-publicized catch-up rules function, and how to think about coordinating your account with a state pension if you have one.

On the surface, a 403(b) and a 401(k) look almost identical. Both allow you to contribute pre-tax dollars that reduce your taxable income today, both allow Roth contributions in many cases, both grow tax-deferred, and both carry the same IRS contribution limits for 2024: $23,000 per year, or $30,500 if you are age 50 or older (IRS Publication 571, 2024).

The differences are more structural than numerical:

• Who sponsors them: 401(k) plans are for private, for-profit employers. 403(b) plans are for public schools, nonprofit hospitals, charities, religious organizations, and other 501(c)(3) entities.
• Investment options: 401(k) plans are required to include a broad menu of options. 403(b) plans historically were only allowed to hold annuity contracts or custodial accounts of mutual funds, a restriction that was relaxed over time but still shapes what many plans offer.
• ERISA protections: Most 401(k) plans fall under the Employee Retirement Income Security Act, which requires fiduciary oversight of investment menus. Many 403(b) plans, particularly those at public schools and churches, are exempt from ERISA, which means less regulatory oversight of the products offered to participants.
• Employer match: Employer matches are common in 401(k) plans and exist in some 403(b) plans, but they are less universal in the nonprofit and education sector.

Understanding which rules apply to your specific plan is a sensible starting point, and your plan documents or HR department can tell you whether your 403(b) is subject to ERISA.

Here is where the 403(b)'s past comes into sharp focus. For much of the 20th century, the only investment products permitted inside a 403(b) were annuity contracts sold by insurance companies. When mutual funds were added as an option in 1974, many plans kept their annuity products alongside them. The result is that today, some teachers and hospital workers are still invested in variable annuities sitting inside their 403(b), carrying multiple layers of fees that a plain mutual fund would not.

A variable annuity inside a 403(b) might carry:

• Mortality and expense (M&E) charges: Typically ranging from 0.5% to 1.5% per year, charged by the insurance company for the insurance wrapper around the investment.
• Administrative fees: Additional flat or percentage-based charges.
• Underlying fund expense ratios: The cost of the mutual funds held inside the annuity.
• Surrender charges: Penalties for moving money out of the contract within a set period, sometimes lasting seven to ten years.

To put this in perspective, consider a hypothetical participant with a $100,000 balance who pays a total annual fee of 2% inside an annuity versus 0.10% inside a low-cost index fund. Over 20 years, assuming 6% annual growth before fees, the higher-fee scenario would produce roughly $20,000 to $30,000 less in final balance, illustrating why fees compound just as powerfully as returns do. This is a hypothetical example for illustration only and does not represent any specific product or outcome.

The good news is that many 403(b) plans, especially those at larger institutions, have improved their menus significantly. Low-cost mutual funds and index funds are increasingly available. But the annuity products often remain as options alongside them, and participants who enrolled years ago may still be in them without realizing it. You can find guidance on evaluating fees at investor.gov, the SEC's investor education site. Our post on what your 401(k) fees are really costing you walks through how compounding fees affect long-term balances in more detail.

Checking your 403(b) fees does not require a finance degree. Here is a practical framework for understanding what you are paying:

Step one: Find your investment options. Log into your plan's portal or request a current investment menu from your plan administrator. Look for a list of available funds and any annuity contracts.

Step two: Locate the expense ratios. For mutual fund options, the expense ratio is the annual cost expressed as a percentage of your investment. It is found in the fund's prospectus or on the fund fact sheet available through your plan. For annuity contracts, look for a contract disclosure or ask your HR department for a fee schedule that lists M&E charges and other costs.

Step three: Add up all layers. Your total annual cost is not just the fund expense ratio. Add any plan-level administrative fees (sometimes called record-keeping fees) and, if you are in an annuity, the insurance charges on top.

Step four: Compare against benchmarks. A broad stock index fund often carries an expense ratio well below 0.20%. If your total fees are significantly higher, it may be worth asking your plan administrator whether lower-cost options are available, or speaking with a financial adviser about your options.

Step five: Review your enrollment elections. Many participants enrolled in a default option years ago and have never revisited it. Checking that your contributions are going into your intended investments is a simple maintenance task that is easy to overlook.

If your plan is subject to ERISA, your employer is required to provide fee disclosure under Department of Labor regulations (DOL Regulation 29 CFR 2550.404a-5). You can learn more about participant disclosure rules at dol.gov.

Most people who are 50 or older know about the standard catch-up contribution, which allows an additional $7,500 per year on top of the regular $23,000 limit in 2024, for a total of $30,500 (IRS Rev. Proc. 2023-34). But 403(b) plans have a second, less-known catch-up provision that applies to certain long-serving employees regardless of age.

Under IRS rules, employees who have at least 15 years of service with an eligible 403(b) employer, including educational organizations, hospitals, home health service agencies, health and welfare service agencies, and churches, may be able to contribute an additional $3,000 per year above the standard limit. This provision has a lifetime cap of $15,000 and is subject to a complex formula that takes into account prior contributions (IRS Publication 571).

A few important points about this provision:

• It applies only to employees of qualifying organizations, not all 403(b) sponsors.
• The IRS requires the 15-year catch-up to be used before the age-50 catch-up when both apply in the same year, though the interaction of these rules is complex.
• Calculating your eligibility requires knowing your total years of service and your cumulative prior contributions, figures your plan administrator should be able to help you verify.
• A tax professional familiar with 403(b) rules or a financial adviser can help assess whether you qualify before you act on this.

For many career teachers and hospital workers who started saving later in their careers, this provision represents a meaningful opportunity that is rarely advertised. The IRS's Publication 571, available at irs.gov, provides the complete rules and worksheet for calculating the allowable amount.

Many teachers and public-sector workers participate in both a 403(b) and a state-defined benefit pension plan. These two vehicles serve different purposes, and understanding how they interact can shape how much you prioritize your 403(b) contributions.

A defined benefit pension delivers a predictable monthly income in retirement based on a formula that typically incorporates your years of service and final average salary. This is fundamentally different from a 403(b), which is a defined contribution plan where your balance depends on what you put in and how your investments perform. The pension handles your baseline income floor; the 403(b) can build the discretionary layer on top of it.

Some considerations when the two coexist:

• Tax diversification: A traditional pension produces fully taxable income in retirement. If your 403(b) contributions are going into a Roth option, you are creating a source of tax-free income alongside your taxable pension, which can offer flexibility when managing your tax bracket in retirement. Our article on retirement tax diversification covers this three-bucket framework in more detail.
• Social Security coordination: Some public school teachers and certain state employees are not covered by Social Security because their employer contributes to a state pension system instead. If that applies to you, your 403(b) takes on additional importance as a supplement to pension income. The Windfall Elimination Provision and Government Pension Offset rules at the Social Security Administration (ssa.gov) may affect benefit calculations for those who do have Social Security-covered earnings in addition to a public pension.
• Required Minimum Distributions: A 403(b) is subject to RMDs beginning at age 73 under the SECURE 2.0 Act (Pub. L. 117-328). Your pension, being paid as an annuity by the pension fund, is not subject to RMDs in the same way. Planning the drawdown sequence of your 403(b) alongside pension income is a coordination exercise that a financial adviser familiar with public-sector benefits can help you work through.
• Vesting timelines: State pension vesting schedules vary by state and plan. In some systems, you may need 10 years of service before you are fully vested in the pension benefit. If you are early in your career and not yet vested, your 403(b) is particularly important as a portable savings vehicle you keep regardless of whether you stay with that employer.

Many 403(b) plans now offer a Roth contribution option alongside the traditional pre-tax option. Roth contributions go in after-tax but grow tax-free and can be withdrawn tax-free in retirement, provided certain conditions are met. The same annual contribution limits apply whether you choose traditional, Roth, or a mix of both.

For educators and nonprofit workers who expect to have meaningful pension income pushing them into higher tax brackets in retirement, a Roth 403(b) is worth understanding. Contributing to the Roth option now, while potentially in a lower bracket, could mean tax-free income later to complement fully taxable pension payments.

The decision between traditional and Roth contributions involves estimating your current versus future marginal tax rates, which is not always straightforward and depends on factors specific to your financial picture. Our comparison of Roth vs traditional accounts explores the considerations that often influence this decision, and a financial adviser can help you model the tradeoffs in your specific situation.

Disclaimer: This article is for general informational and educational purposes only. It does not constitute personalised financial, tax, or investment advice. Rules and limits referenced are based on IRS and DOL guidance current as of 2024 and may change. Everyone's financial situation is different. Please consult a qualified financial adviser and, where appropriate, a tax professional before making any decisions about your retirement savings, investment selections, or plan elections.