Under the Internal Revenue Code, a 403(b) plan is a retirement plan that can be offered to employees of public schools, employees of certain 501(c)(3) tax-exempt organizations and eligible church ministers. This type of retirement savings plan allows participants to make pre-tax contributions, and earnings on the contributions are not taxed until they are distributed from the plan.
Contributions to a 403(b) plan, also called a tax-sheltered annuity plan, are typically deducted from an employee's pay on a pre-tax basis using a salary reduction agreement. Under Internal Revenue Service regulations, the end effect is to lower the employee's taxable pay and current federal income tax burden.
Each year, the IRS sets limits on the amount of pre-tax income an employee can contribute to a 403(b) plan. For 2015, the limit has been set at $18,000, while the limit was $17,500 in 2013 and 2014. The IRS penalizes individuals who contribute more than the set limit to a 403(b) retirement plan.
Plan participants direct the investment of their contributions, called elective deferrals, by picking investment vehicles offered through their employer, as explained by the IRS. These elective investments can rise or fall in value based on market conditions, so it is possible for an employee's 403(b) retirement fund to have a lower value than the amount contributed.