The pros and cons of 403(b)s

Are you a teacher or do you work in a tax-exempt sector?

There is more than $1.1 trillion invested in 403(b) retirement accounts, which is an increase of more than $250 billion in just the last 10 years.¹

And yet, unless you are employed in certain professions, with the massive shadow cast by the more than $7 trillion invested in 401(k)s, basic information and guidance about 403(b) accounts is not always easy to find.²

This was recently driven home to me at a social function.

I was introduced to a school district supervisor, and I was a bit surprised by how little she knew about her district’s 403(b). So, what might have been a quick conversation turned into more than an hour of 403(b) instruction.

If you are invested in, or have access to, a 403(b) plan, here are some things you should know.

What is a 403(b) plan and how does it differ from a 401(k)?

As I mentioned above, a 403(b) plan isn’t available to just anyone. A 403(b) is the retirement account most widely available to public school employees and to people who work for tax-exempt entities (non-profits).

While not identical, with plan contribution limits, employer-contribution matching, age-related catch-up contributions, pre-tax payroll deductions/contributions, and tax-free growth, 403(b)s are like 401(k)s.

But beware, just a couple of the ways that 403(b)s differ from 401(k)s are that the investment options in the former tend to be more limited than 401(k)s, and, more importantly, many 403(b) accounts offer less protection from creditors than their 401(k) cousins. In short, if you’re faced with a lawsuit by a creditor, unlike what is typically the case with 401(k)s, the money in your 403(b) account could be vulnerable if a legal judgment doesn’t go your way.

How do 403(b)s work?

Whereas 401(k)s are generally available through private sector employers, 403(b)s are likely to be available to:

• People who are employed by churches, including ministers and clergy
• Public school employees (including those of Indian tribal governments)
• People who work in primary, secondary, or higher public education, including state colleges and universities

As of the publication of this article, 403(b)s have the same personal contribution limits as 401(k)s, which is $23,000 for 2024, with a catch-up contribution of $7,500 if you are 50 years of age, or older.

But beware: You must be 59½ to withdraw money from your 403(b), or you’ll get hit with a 10% early withdrawal penalty.

What are the main advantages and disadvantages of 403(b) plans?

Among the most enticing advantages of tax-deferred retirement accounts is that the money is automatically withdrawn from your paycheck before taxes are deducted, and so this lowers your taxable income at the same time it enables you to invest more for the future. You also won’t pay taxes until years later when you withdraw the money.

Another advantage (though this has drawbacks, as well) of 403(b)s (over even a 401(k)), is that because they are less likely to be subject to the oversight of ERISA (Employee Retirement Income Security Act), the fees tend to be lower.

And this can mean that more money stays invested and working for you.

403(b)s also typically offer their participants faster (or even immediate) vesting, which is something few 401(k)s do. (This means that the money is yours without years of waiting to qualify via an onerous vesting schedule.)

But beware: While a terrific savings vehicle, 403(b)s have some drawbacks. 403(b)s have a narrower range of investments than 401(k)s, and many plans over-emphasize, or even prioritize, annuities as the primary investment option. And, as I mentioned previously, because 403(b) plans are not as likely to be required to be ERISA compliant, your protection from creditors probably will not be as robust as that of a 401(k).

While not all are created equal, with tax-deferred growth and employer-matching, I’m of course a huge advocate of defined contribution plans. Just make certain you are aware of the rules and regulations regarding your specific plan, and, most importantly, before you retire, or move that money out of your plan, take a distribution, or even change jobs, speak to a fiduciary advisory, as mistakes can be costly and are usually impossible to reverse.

^{1 Total 403(b) Assets Grew, Options Shrank: Study - The NonProfit Times}

^{2 Retirement Account Statistics - NerdWallet}