All deferrals to a 403(b) plan within the maximum amount contributable (MAC) are tax-deferred. Tax is deferred on the contributions, the net investment income, and realized capital gains that accumulate in the plan until the individual begins making withdrawals from it.

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 due to earnings and appreciation. If the teacher chooses to receive a lump-sum payout, the entire amount ($16,000) will be taxed as ordinary income.

There are several ways to withdraw funds from a 403(b) plan. Funds may be taken in a lump sum or in a periodic payments. In most cases, taking periodic payments will reduce the tax burden on distributions, since a lump sum payment may put the recipient in a higher income tax bracket.