The 403(b) plan, named for section 403(b) of the Internal Revenue Code, is a type of retirement plan under which participants are eligible to receive special tax benefits. The money contributed to a 403(b) comes from before-tax dollars. These dollars are deducted from one's paycheck before they are taxed. Thus, salary you contribute to one of these retirement plans are not taxed while they remain in the fund (although how much may be contributed pre-tax is limited).

Employees of public education and non-profit organizations, such as hospitals, museums, public foundations, churches, research organizations, and local governments are eligible for participation in 403(b) plans. Part-time employees may participate in all plans unless they are expressly prohibited because of individual plan requirements. In addition, the employer may establish eligibility guidelines for different classes of employees.

In most cases, contributions to a 403(b) plan are made from employees' elective deferrals. The employee signs a salary reduction agreement with the employer, authorizing him or her to deduct a certain amount from the employee's wages. The employee's W2 will reflect the lower taxable income. This money is used to purchase an annuity contract or invest in a mutual fund. This annuity or mutual fund is the vehicle in which the 403(b) plan is invested.

The individual may elect to defer an amount up to the allowable contribution limit for the year. This is pre-tax, so no deduction can be taken on a tax return. The employee's W2 will reflect the lower taxable income. The individual is not taxed on the contributions and earnings until the individual begins receiving distributions.

For example, imagine a teacher who paid $10,000 into a 403(b) over several years. Suppose that the account is now worth $16,000. If the teacher chooses to receive a lump sum payout, the entire amount ($16,000) will be taxed as ordinary income.

It should be noted that participation in a 403(b) plan qualifies as participation in an employer-sponsored retirement program. This may have consequences for an individual who is putting money into a second retirement plan. Someone who contributes to a 403(b) plan may not be eligible (depending upon his or her income) to deduct contributions to an individual retirement account.

403(b) plans offer the employees of non-profit organizations many of the same kinds of retirement investing and tax savings benefits that 401(k) plans have traditionally offered to employees of for-profit organizations.

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