403(b) Plan

A 403(b) Plan (also known as a Tax-Sheltered Annuity or TSA Plan) is a retirement savings plan available in the United States, specifically for employees of public schools, certain non-profit organizations, and ministers. Think of it as the cousin to the more famous 401(k) plan, but tailored for the public service and non-profit sectors. The name “403(b)” simply refers to the section of the Internal Revenue Code that governs its rules. The core magic of a 403(b) plan lies in its tax advantages. Typically, you contribute a portion of your salary before taxes are calculated, which lowers your taxable income for the year. Your money then grows inside the plan, sheltered from annual taxes on investment gains—a concept known as tax deferral. This allows the power of compounding to work more effectively over the long term. You only pay income tax on the money when you withdraw it in retirement, presumably when you might be in a lower tax bracket.

Unlike a 401(k) which is offered by for-profit companies, the 403(b) is exclusive to a specific group of professionals dedicated to public service and charitable work. If you work for one of the following, you're likely on the guest list:

• Public Education Institutions: This is the largest group and includes teachers, administrators, janitors, and other staff working for public schools, from elementary schools to state colleges and universities.
• 501©(3) Tax-Exempt Organizations: This is a broad category that includes non-profit hospitals, charities, religious groups, and private universities. If your employer is a registered non-profit, a 403(b) might be your retirement plan.
• Ministers: Certain ministers and other church employees can also participate in 403(b) plans.

Understanding the mechanics of your 403(b) is the first step toward using it wisely. The two key features are how you contribute and how your money grows.

The most common way to contribute to a 403(b) is with pre-tax dollars. This provides an immediate, tangible benefit. Here's a simple example: Let's say you earn $60,000 a year and decide to contribute $6,000 to your 403(b). Your employer deducts that $6,000 from your paycheck before calculating income tax. As a result, the government only taxes you on $54,000 of income for that year. This reduces your tax bill today, leaving more money in your pocket or, even better, allowing you to invest more for your future.

Once your money is in the 403(b) plan, it gets to work. Whether your investments generate interest, dividends, or capital gains, you pay no tax on that growth year after year. In a standard brokerage account, you'd owe taxes on these gains annually, creating a “tax drag” that slows down your wealth-building. By deferring taxes until retirement, a 403(b) plan lets your entire investment, including all its earnings, continue to grow and compound on itself. It’s like a snowball rolling downhill, gathering more snow without anything slowing it down.

Some employers also offer a Roth 403(b) option. It flips the tax benefit on its head.

• Contributions: You contribute with after-tax dollars. This means you don't get the immediate tax deduction on your contributions.
• Withdrawals: In exchange, all your qualified withdrawals in retirement—both your original contributions and all the investment growth—are 100% tax-free.

A Roth 403(b) can be a brilliant choice if you believe you'll be in a higher tax bracket in retirement than you are today. You pay the taxes now while your rate is lower and enjoy tax-free income later when it matters most.

This is where a value investor's mindset is crucial. A 403(b) is just a container; what you put inside it determines your success. Historically, 403(b) plans were infamous for offering limited and expensive investment options, primarily annuities.

An annuity is a contract with an insurance company. While they can have a place in some financial plans, the variable annuities often pushed in 403(b) plans can be loaded with high fees. These can include mortality and expense charges, administrative fees, and surrender charges if you try to move your money too soon. These layers of costs can devour your investment returns over time. As a value-conscious investor, you must be skeptical and read the fine print. Always ask about the total, all-in cost.

Thankfully, the 403(b) landscape has improved dramatically. Many plans now offer a wide selection of low-cost mutual funds. These are often the superior choice for long-term growth.

• Look for Index Funds: A low-cost index fund that tracks a broad market index like the S&P 500 is a fantastic, core holding for most investors. Their fees, or expense ratios, are typically a fraction of what expensive annuities charge.
• Consider Target-Date Funds: If you prefer a hands-off approach, a target-date fund can be a great option. It automatically adjusts its mix of stocks and bonds to become more conservative as you approach your planned retirement date. Just be sure to check its fees as well.

To make the most of your 403(b) plan, approach it with discipline and a focus on value.

• Check the Fees, Then Check Again: High fees are the enemy of long-term returns. Scrutinize the expense ratios of your funds and ask about any plan administration or “wrap” fees. A 1% difference in fees can mean tens or even hundreds of thousands of dollars less in retirement.
• Understand Your Options: Don't just accept the default investment. Compare the low-cost mutual funds against any annuity products offered. Nine times out of ten, the low-cost fund is the better long-term choice.
• Contribute Consistently: Automate your contributions from every paycheck. If your employer offers a match (less common in 403(b)s but possible), contribute at least enough to get the full match—it's free money!
• Stay the Course: Once you've set up a sound, low-cost investment plan, let it work. Don't panic and sell during market downturns. A true value investor knows that volatility is part of the journey.