403(b) Tax Deduction Rules

The thought of eventually leaving the workforce and enjoying your retirement years may put a smile on your face. But knowing you have an income cushion from your retirement plan can sweeten the deal even more. While a myriad of savings options are available to workers, only a certain niche qualify for a 403(b) retirement plan, including employees of public schools, churches and nonprofits. And if you qualify for this program, you’ll also qualify for a 403(b) tax deduction.

403(b) Vs. 401(k)

A 403(b) retirement plan is a counterpart of sorts to a 401(k) plan. Both plans help workers save for retirement; both plans are employer-sponsored savings plans; and both plans allow their participants to make tax-deferred contributions. The primary difference, however, is that 403(b) plans are structured for certain employees of 501(c)(3) nonprofits, churches and public schools, and 401(k) plans are structured for private-sector employees.

403(b) Tax Deduction Rules

If your employer has a traditional 403(b) plan, you’ll enjoy a pretax contribution benefit. This means that you will not pay income tax on your contributions, or the interest that your plan earns, until you withdraw your money at retirement. Essentially, the amount of your 403(b) contribution lowers your taxable income, which may put you in a lower tax bracket.

If your employer has a Roth 403(b) plan, you’ll pay income tax on the contributions you make to your plan, but you’ll be able to withdraw tax-free money at retirement.

403(b) Contribution Limits

As of 2019, eligible employees may contribute up to $19,000 each year to their 403(b) plans. Employees who are 50 years and older may make an additional contribution of up to $6,000. And if an employee has 15 years of service with the same qualifying 403(b) company, she may be able to make an additional contribution up to $3,000. IRS Publication 571 addresses this 15-year rule.

Some 403(b)-classified companies make matching contributions, which vary, depending on the company’s policies. Check the 403(b) employer contribution rules for your plan to see if you’re eligible for this additional benefit.

403(b) Part-Time Employees

If you typically work at least 20 hours each week as a part-time employee, you are eligible to invest in a 403(b) plan. You'll have to contribute at least $200 each year, and you cannot participate in another company's 403(b) plan to remain eligible.

Receiving 403(b) Distributions

You can make withdrawals, called distributions, without penalty from your 403(b) plan when you reach age 59 1/2, leave your job, become disabled or experience a financial hardship. The IRS defines a financial hardship as one that's due to an immediate and heavy financial need. The amount of a hardship distribution can only be equal to the amount that’s necessary to satisfy the financial need. Your heirs can receive penalty-free distributions upon your death even if you have not reached the age of 59 1/2.

Some qualified military reservists are also exempt from having to pay an early distribution penalty, such as those who are on active duty for a period of more than 179 days. IRS Publication 571 defines penalty-free distribution allowances.

403(b) Investment Options

Your 403(b) contributions may be invested in an insurance company's annuity contract, a custodial account that invests in mutual funds or a retirement income account. Some employers offer a single investment option, but your employer may offer preselected investment options from which you'll choose a specific 403(b) plan provider. Regardless of the investment vehicle, you'll have the same tax deduction benefits.