What Is a Tax-Sheltered Annuity? How 403(b) Plans Work

A tax-sheltered annuity, better known today as a 403(b) plan, is a retirement account for employees of public schools, hospitals, churches, and other tax-exempt nonprofits. You authorize your employer to redirect part of each paycheck into the account before federal income tax is calculated, the balance grows tax-deferred, and you pay income tax when you withdraw the money in retirement. For 2026, the basic salary deferral limit is $24,500, with additional catch-up amounts available depending on your age and years of service.¹

Who Can Offer and Join a 403(b)

Federal tax law limits 403(b) plans to two categories of employers. The first is organizations that qualify as tax-exempt under Section 501(c)(3), which covers charities, religious organizations, hospitals, and private foundations. The second is public educational institutions, including K-12 school districts, community colleges, and state universities.² If your employer is a for-profit company, you cannot participate in a 403(b); the equivalent workplace plan in the private sector is the 401(k).

Eligibility inside a qualifying employer depends on who signs your paycheck, not your job title. A custodian, a classroom teacher, and a school district’s finance director all have the same right to participate.

2026 Contribution Limits

The core mechanism is the elective deferral: you tell your employer how much of each paycheck to withhold and route into the plan. For 2026, that base deferral tops out at $24,500.¹ Three catch-up rules can push your personal ceiling higher.

If you are 50 or older, you may add an extra $8,000, bringing your limit to $32,500. If you turn 60, 61, 62, or 63 during the year, an enhanced catch-up of $11,250 replaces the standard $8,000, raising the ceiling to $35,750. Once you reach 64, you drop back to the $8,000 amount.³

The third catch-up is unique to 403(b) plans. If you have worked full-time for the same qualifying employer for at least 15 years, you may contribute an extra $3,000 per year, subject to a $15,000 lifetime cap. The 15-year catch-up stacks on top of the age-based catch-up when both apply.⁴

Employer matching or nonelective contributions count separately from your deferral but share a combined ceiling. The total of employee and employer contributions cannot exceed $72,000 for 2026 under the Section 415(c) annual additions limit.¹ Employer matches are less common in 403(b) plans than in 401(k) plans, but larger hospitals and school systems increasingly offer them.

The New Roth Rule for Higher Earners

Starting January 1, 2026, if your wages from the plan sponsor exceeded $150,000 in 2025, any catch-up contributions you make must go into a Roth (after-tax) account rather than a traditional pre-tax account.⁵ Your base $24,500 deferral can still be pre-tax; only the catch-up portion is affected. If your plan does not offer a Roth option, your employer has to add one or you lose the ability to make catch-up contributions at all.

Roth or Traditional Inside the Plan

Most 403(b) plans now offer both a traditional pre-tax account and a Roth account. The combined limit across both is $24,500 for 2026 plus any catch-up amounts, not $24,500 each.¹

With traditional pre-tax contributions, you skip income tax now and pay it when you withdraw the money in retirement. With Roth contributions, you pay income tax upfront, but qualified withdrawals in retirement are completely tax-free, including all the investment earnings. A Roth withdrawal is qualified once the account has been open for at least five years and you have reached age 59½, become disabled, or passed away.

The choice depends on whether you expect your tax rate to be higher or lower in retirement. Teachers and nonprofit workers who anticipate a pension on top of Social Security sometimes find themselves in a higher bracket than they expected, which makes the Roth worth serious consideration. Splitting contributions between both accounts hedges the bet.

How the Money Is Invested

Money inside a 403(b) is typically held in one of two vehicles. Annuity contracts, issued by insurance companies, come in fixed varieties (guaranteed interest rate for a set period) and variable varieties (returns tied to underlying stock and bond portfolios). Custodial accounts, authorized under Section 403(b)(7), hold mutual fund shares through a bank or other qualified custodian.²

Fees deserve more scrutiny in 403(b) plans than in most workplace retirement accounts, because many school district plans historically defaulted to high-cost annuity contracts. A GAO study of 403(b) plans found expense ratios on mutual fund options ranging from as low as 0.02% to over 3.7%, with a median around 0.9%. Annuity contracts often carry surrender charges if you move your money before a set period, with some providers imposing surrender fees as high as 10% and phase-out periods stretching 15 years.⁶

A 1% difference in annual fees sounds trivial. Over a 30-year career, it can consume tens of thousands of dollars in lost growth. Before picking a provider from your employer’s approved vendor list, compare expense ratios and check whether the annuity contract locks you in with surrender charges. Low-cost index mutual funds in a custodial account are usually the cheapest option if your plan offers them.

Getting Money Out

The plan is designed to keep money in until retirement, and the tax code enforces that design. A few doors do open earlier.

Plan Loans

You can borrow from your own account balance up to the lesser of 50% of your vested balance or $50,000. If your vested balance is under $20,000, you may borrow up to $10,000 even if that exceeds 50%. You repay the loan with interest to your own account through payroll deductions over up to five years, with a longer window allowed for loans used to buy a primary residence.⁷ If you leave your employer with a loan outstanding and do not repay it by the tax-filing deadline for that year, the remaining balance is treated as a taxable distribution.

Hardship Withdrawals

A hardship withdrawal, unlike a loan, does not get repaid. You permanently reduce your retirement balance, and the withdrawn amount is subject to income tax plus, usually, the 10% early withdrawal penalty. Plans that offer hardship withdrawals recognize a fixed set of qualifying situations: unreimbursed medical expenses; costs tied to buying a principal residence; tuition, fees, and room and board for the next 12 months of postsecondary education; payments to prevent eviction or foreclosure on your principal residence; funeral expenses for you or family members; and certain casualty repair costs for your principal residence. Not every 403(b) plan offers hardship withdrawals, so check your plan document.⁸

Withdrawals Before Age 59½

Taking money out before age 59½ normally triggers a 10% additional tax on top of the regular income tax. Several exceptions waive that penalty. You avoid it if you separate from service during or after the year you turn 55 (age 50 for public safety employees of state or local governments), become totally and permanently disabled, take substantially equal periodic payments over your life expectancy, need up to $5,000 for a birth or adoption, have unreimbursed medical expenses over 7.5% of your adjusted gross income, are certified as terminally ill, take up to $22,000 after a federally declared disaster, or receive the funds under a qualified domestic relations order in a divorce.⁹

Required Minimum Distributions

Once you reach age 73, you must begin taking annual required minimum distributions. The age 73 threshold applies to individuals born between 1951 and 1959. Under the SECURE 2.0 Act’s phased schedule, the RMD age rises to 75 for those born in 1960 or later.¹⁰ If you are still working for the employer sponsoring the 403(b) past your RMD age, you can generally delay RMDs from that plan until the year you actually retire, unless you own 5% or more of the employer.¹¹

Missing an RMD is expensive. The penalty is an excise tax equal to 25% of the shortfall between what you should have withdrawn and what you actually took. The rate drops to 10% if you correct the shortfall and file the appropriate return within the correction window, which generally ends at the close of the second tax year after the penalty was triggered.¹²

Rollovers When You Leave

When you separate from your employer, you can roll the 403(b) balance into a traditional IRA, a new employer’s 401(k), or another eligible retirement plan. A direct rollover, where the old plan sends the money straight to the new custodian, avoids tax withholding. If the check is made payable to you instead, the plan must withhold 20% for federal taxes, and you have 60 days to deposit the full distribution amount (making up that 20% from other funds) into the new account. Any amount not rolled over within 60 days becomes taxable income and may face the 10% early withdrawal penalty if you are under 59½.¹³ The receiving plan is not required to accept rollovers, so confirm before initiating the transfer.

How a 403(b) Differs From a 401(k)

The two plans share the same core deferral limit ($24,500 for 2026), the same age-based catch-up amounts, and the same basic tax treatment. The differences come down to who offers them and a few structural details.

A 401(k) is available through for-profit employers, while the 403(b) is restricted to public schools and 501(c)(3) nonprofits. The 403(b) has the 15-year service catch-up, which 401(k) plans do not, and that provision can add up to $15,000 in extra lifetime contributions for long-tenured employees.⁴ On the other side, 401(k) plans typically offer a wider range of investment options, while many 403(b) plans still lean on annuity contracts with higher fees and fewer choices. Employer matching is also more common in the 401(k) world, though the gap has narrowed. If you move between the nonprofit and for-profit sectors, you can generally roll a 403(b) into a 401(k) and vice versa when you change jobs.

1
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs
2
Office of the Law Revision Counsel. 26 USC 403 – Taxation of Employee Annuities
3
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
4
Internal Revenue Service. 403(b) Plans – Catch-Up Contributions
5
Internal Revenue Service. Treasury, IRS Issue Final Regulations on New Roth Catch-Up Rule, Other SECURE 2.0 Act Provisions
6
United States Government Accountability Office. Defined Contribution Plans – 403(b) Investment Options, Fees, and Other Characteristics Varied
7
Internal Revenue Service. Retirement Plans FAQs Regarding Loans
8
Internal Revenue Service. Retirement Topics – Hardship Distributions
9
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
10
Federal Register. Required Minimum Distributions
11
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
12
Office of the Law Revision Counsel. 26 USC 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans
13
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions