A 403(b) plan is a retirement account available only to some ministers, employees of qualifying tax-exempt organizations and employees of public schools. An account holder can contribute to the plan, or employers can contribute on behalf of the account holder. Most contributions to 403(b) plans are exempt from income taxes.
Because contributions to 403(b) plans are typically tax-free, employers may exclude them from the income reported on your W-2. If not, you can deduct contributions from your taxable income when you file your return. You can make contributions to your 403(b) account directly from your income, or your employer can make them for you as an elective deferral, which requires a reduced-salary agreement. The Internal Revenue Service limits the amount of money you can contribute to a 403(b) plan during a single year.
If you exceed the limit for tax-free contributions during the year, you may owe income tax on the excess amount. As of 2012, the maximum amount of tax-free contributions that you can make in the form of elective deferrals is $17,000. The maximum amount of all contributions you can make to a 403(b) plan is $50,000 or 100 percent of your taxable income, whichever is smaller.
Taxes on Withdrawals
When you withdraw funds from your 403(b) account, you will owe income tax on the amount you receive. You cannot withdraw funds from a 403(b) account until you reach age 59 1/2 or stop working. If you withdraw funds early, you will owe a 10 percent penalty in addition to income tax. At age 70 1/2, you must take a minimum required distribution. If you fail to do so, you will owe a 50 percent excise tax on the difference between your required distribution and the amount you actually took.
Though you won't pay income tax on contributions to a 403(b) retirement plan, you must still pay Social Security and Medicare taxes. Your employer will also pay unemployment tax and the employer's share of Social Security and Medicare taxes on these wages. Some plans allow you to make after-tax contributions to your account in addition to your pre-tax contributions. In such cases, you will pay income tax on the after-tax contributions you make.