IRC 403(b) Tax-Sheltered Annuity Plans

 

A 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees' accounts.

Choose a 403(b) Plan

A 403(b) plan (tax-sheltered annuity plan or TSA) is a retirement plan offered by public schools and certain charities. It's similar to a 401(k) plan maintained by a for-profit entity. Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary into individual accounts. The deferred salary is generally not subject to federal or state income tax until it's distributed. However, a 403(b) plan may also offer designated Roth accounts. Salary contributed to a Roth account is taxed currently but is tax-free (including earnings) when distributed.

Eligible employers are a:

  • public school, college, or university,
  • church, or
  • charitable entity tax-exempt under Section 501(c)(3) of the Internal Revenue Code

Pros and Cons:

  • Flexibility in contributions
  • Investment options are limited to those chosen by the employer
  • may have high administrative costs
  • optional loans and hardship distributions add flexibility for employees

Contribution Type - Employee salary deferrals; employer may contribute.

Contribution limits - Total contributions to each employee’s 403(b) account or annuity are limited.

Filing requirements - Certain 403(b) plans may be subject to annual Form 5500 filing requirements.

Participant loans - Permitted if the terms of the plan allow loans.

In-service withdrawals - Yes, but subject to possible 10% penalty if under age 59-1/2.

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Participate in a 403(b) plan

The following employees are eligible to participate in a 403(b) plan:

  • Employees of tax-exempt organizations established under IRC Section 501(c)(3).
  • Employees of public school systems who are involved in the day-to-day operations of a school.
  • Employees of cooperative hospital service organizations.
  • Civilian faculty and staff of the Uniformed Services University of the Health Sciences (USUHS).
  • Employees of public school systems organized by Indian tribal governments.
  • Certain ministers if they are:
    • Ministers employed by Section 501(c)(3) organizations.
    • Self-employed ministers. A self-employed minister is treated as employed by a tax-exempt organization that is a qualified employer.
    • Ministers (chaplains) who meet both of the following requirements.
      • They are employed by organizations that are not Section 501(c)(3) organizations.
      • They function as ministers in their day-to-day professional responsibilities with their employers.

Universal availability rule

The "universal availability rule" means that if an employer permits one employee to defer salary into a 403(b) plan, the employer must extend this offer to all employees of the organization.

The employer may exclude certain employees from the plan:

  • Employees who will contribute $200 or less annually
  • Those employees who participate in a 401(k) or 457(b) plan or in another 403(b) plan of the employer
  • Nonresident aliens
  • Employees who normally work less than 20 hours per week
  • Students performing services described in IRC Section 3121(b)(10)

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Establish a 403(b) plan

Only public educational institutions or 501(c)(3) tax-exempt organizations may establish a 403(b) plan. The general steps to establish a 403(b) plan are:

1. Adopt a written program

All 403(b) plans, except church plans that do not contain any retirement income accounts, must have a written program that must contain mandatory provisions and may contain other optional provisions.

2. Establish annuity contracts or custodial accounts for plan participants

Individual accounts in a 403(b) plan can be any of the following:

  • An annuity contract, which is a contract provided through an insurance company;
  • A custodial account, which is an account invested in mutual funds; or
  • A retirement income account set up for church employees that can be invested in either annuities or mutual funds. 403(b) plans cannot be funded with life insurance (issued after September 24, 2007), endowment, health, accident or other types of insurance contracts. The employer, who is responsible for ensuring its plan complies with all legal requirements, should verify that there is no conflict between the terms of the 403(b) plan and the provisions of any annuity contract or custodial account agreement under the plan. The plan’s terms will overrule any inconsistencies. 

3. Obtain an identification number for the plan
403(b) plans that are subject to ERISA must comply with DOL regulations, which may include obtaining an employee identification number (EIN) for the plan. Governmental, non-electing church and other 403(b) plans that meet the safe-harbor requirements under the DOL regulations are not subject to ERISA.
 
4. Provide information to employees and meet other obligations
403(b) plans that are not exempt from ERISA must also supply information to plan participants, including a Summary Plan Description PDF PDF, and must meet other fiduciary obligations PDF PDF.


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Operate and maintain a 403(b) plan

An eligible employer that has established a 403(b) plan must operate and maintain the plan by taking certain actions to ensure it continues to provide tax-deferred benefits to plan participants.

Follow the terms of the plan
An employer must operate its 403(b) plan according to its written program or the plan may be disqualified. This may lead to the loss of tax-deferred status for all plan contracts.

Deposit employee contributions in a timely manner
You must deposit all contributions to a 403(b) plan account or transfer them to an annuity contract issuer within a period that is not longer than is reasonable for the proper administration of the plan. 403(b) plans governed by ERISA may be subject to more restrictive requirements.

Reporting and participant disclosure
Certain 403(b) plans may be subject to annual Form 5500 filing requirements, and all plans are required to provide information to participants. See Retirement Plan Reporting and Disclosure for a chart of the requirements.

Conduct periodic reviews
The IRS provides checklists and tips to help you conduct periodic reviews of your 403(b) plan. See Have you had your retirement plan check-up this year?

Update the plan document for recent law changes
See Amend or Update a Plan. You must amend your plan document periodically to comply with current law. The IRS provides resources to help you keep your plan up-to-date, including sample plan language.

Nondiscrimination testing
The plan administrator may need to conduct annual testing to determine whether the plan complies with required nondiscrimination provisions for eligibility and benefits. This requirement depends on the type of organization sponsoring the plan and/or the type of 403(b) plan.

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Correct 403(b) plan errors

Find, fix and avoid plan errors.
Correcting Plan Errors
403(b) Fix-It-Guide
403(b) Plan Checklist PDF (PDF)

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Terminate a 403(b) plan

If allowed by the terms of the plan, a 403(b) plan sponsor (employer) may terminate the plan and distribute accumulated benefits to the participants and beneficiaries on termination.

To terminate a 403(b) plan, the plan sponsor must take the following steps:

  • Adopt a binding resolution:
  1. establishing a plan termination date,
  2. ceasing plan contributions,
  3. fully vesting all benefits on the termination date, and
  4. authorizing the distribution of all benefits as soon as administratively practicable after the termination date;
  • Generally, stop contributions by the sponsor or any related entity to any other 403(b) plan during the period that begins on the termination date and ends 12 months after all benefits have been distributed from the terminated plan (this requirement may be disregarded if at all times during the period beginning 12 months before the termination and ending 12 months after all benefits have been distributed, fewer than 2% of the employees who were eligible to participate in the terminated plan are eligible to participate in another 403(b) plan of the sponsor);
     
  • Notify all plan participants and beneficiaries about the plan’s termination;
     
  • Provide a 402(f) rollover notice to participants and beneficiaries; and
     
  • Distribute all plan assets within 12 months of the plan’s termination date to participants and beneficiaries in accordance with Rev. Rul. 2011-7.

403(b) plans subject to ERISA may have to comply with additional requirements.

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Additional resources

Find more information on forms, publications and other 403(b) resources.