Regarding retirement planning, all the options available can get confusing. There are many plans out there, but do you know the difference between 401(k), 403(b), 457(b), 401(a), and all the others?
Most people have trouble comparing all the different retirement plans that might be available. Luckily, we are here to help! If you are choosing between a 403(b) and a 401(k), then you are in the right place.
We will explain everything you need to know about both plans and their key differences. Keep reading to learn more about these two plan types.
How A 403(b) Plan Works
The 403(b) plan is much like a 401(k) for government employees and employees of non-profit organizations. These plans are not considered qualified retirement plans. They were created by law and recognized by the IRS in 1958.
The law at the time stated that investments in these plans were limited to annuity contracts. For that reason, they were often referred to as tax-sheltered annuities or tax-deferred annuities. While the investment options have expanded slightly since then, the options in this type of plan are much more limited than those in some other traditional retirement plans.
- At the basic level, a 403(b) plan allows the participant to contribute funds tax-deferred for retirement. The investments in the plan grow tax-free until the participant begins taking withdrawals at retirement.
- In the current year, the participant’s taxable income is reduced by the amount that goes into the plan. You may contribute up to $23,000 to your 403(b) plan in a year. If you are over 50, you can make an additional catch-up contribution of $7,500.
- Your employer might also decide to make matching contributions to your plan. However, your plan’s total deposits between employee and employer contributions cannot exceed $69,000 for 2024.
Regarding distributions, a 403(b) is very similar to a 401(k). You may begin taking distributions at age 59 1/2 without a penalty. At that time, you will pay regular income taxes on any distributions you receive.
If you take a distribution before reaching age 59 1/2, then you will be subject to an additional 10% penalty on that money. Roth options are available, and withdrawals from a Roth plan are generally tax-free.
Minimum distributions are required upon reaching age 73. The only way to avoid these RMDs is to roll your plan into a Roth IRA or other Roth retirement account.
KEY TAKEAWAYS
- Unlike 401(k) plans, 403(b) plans are not considered a Qualified Retirement plan because they are not subject to ERISA.
- Almost all employers can offer a 401(k) plan, but it is most common in the private sector. A 403(b) plan is limited to educational institutions and tax-exempt organizations.
- A 403(b) plan has some unique catch-up contribution provisions but is more limited in investment options.
How Does A 401(k) Work
The 401(k) plan is probably one of the most common retirement accounts in the private sector. It functions very similarly to a 403(b) plan.
These accounts are considered defined contribution plans, and according to the IRS, they are also qualified retirement plans because they are protected by the Employee Retirement Income Security Act (ERISA).
- Employees can make tax-deferred contributions to the plan, and these savings are allowed to grow tax-free in the plan until retirement age.
- An employee may make elective deferrals of up to $23,000 per year into his or her 401k with additional catch-up contributions of $7,500 per year after age 50.
- The employer match is a big plus to the 401(k) as many for-profit companies offer matching funds to help their employees grow their retirement savings.
- If you need to withdraw money from your 401(k) before age 59 1/2, you can expect to pay an early withdrawal penalty. The standard 10% penalty will apply in this case.
Most 401(k) plans have a vesting period. You might lose some of your employer’s matching funds if you leave the company before fully vested in the plan. This time period can range anywhere from a few months to a couple of years.
Some 401(k) plans allow for loans without penalty, although you should check your plan documentation for specifics. Upon reaching age 73, you will be forced to take the required minimum distributions (RMDs) from your account.
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403(b) vs 401(k) Retirement Plans: Comparison And Key Differences
So, what is the difference between a 401k and 403b? At the very basics, these two plans are pretty similar. Many critical provisions between the plans are the same, although there are a few essential differences. Here, we will look at the similarities and differences between these plans in a few significant areas.
Eligibility Rules
This is one of the main differences between the two plans. Any employer may offer a 401(k) plan, and that employer must allow almost all employees to participate, with only a few exceptions.
- The employer may limit participation by union employees or non-resident aliens with no U.S. income. Still, it cannot exclude those over 21, have over one year of service, and work over 1,000 hours per year.
On the other hand, a 403(b) can only be offered by educational institutions and tax-exempt organizations.
- All employees are eligible to participate, but employers may limit their participation rules more tightly than with a 401k.
This applies to both government employers and non-profits.
Early Withdrawal Rules
As with most retirement savings plans, you will pay an early withdrawal penalty in 401(k) and 403(b) if you withdraw funds before reaching 59 1/2.
- A 10% penalty will be assessed on the amount of funds withdrawn.
Sometimes, your plan sponsor may allow loans from your plan without a penalty. Some employers provide This employee benefit but are not required to allow plan loans.
Both plans allow for rollovers into an IRA or Roth IRA without penalty, but a 403(b) plan will probably not make you eligible for a mega backdoor Roth.
Tax Consequences
Again, the tax consequences of these plans are nearly identical. The contributions to the plan are not counted toward the employee’s ordinary income in the current year. Instead, income tax is paid when withdrawals from the plan are taken.
- Both plans offer Roth options that allow an employee to contribute after-tax dollars to the plan.
This means that withdrawals from a Roth 401(k) or Roth 403(b) can be taken tax-free. You should check with your plan sponsor to determine the types of plans available to you and whether you have access to a Roth option.
Catch Up Contributions
Under both plans, employees aged 50 and older may make catch-up contributions to help grow their savings more quickly. Both plans allow for annual catch-up contributions of $7,500.
- The 403(b) contribution limits also allow for an additional $3,000 if you have been with your employer for at least 15 years.
- A 401(k) does not have this particular catch-up option.
Contribution Limits
The contribution limits for these plans for employees are roughly the same. Each plan allows for contributions up to $23,000 per year, with additional catch-up contributions of $7,500 per year for those over age 50.
- Employer matching contributions of up to 25% of the employee’s compensation can be made into the plan, not to exceed total contributions of $69,000.
- One special provision of the 403(b) plan that allows for even more contributions is that an additional $3,000 may be contributed to the plan if the employee has more than 15 years of service.
Range Of Investment Options
The range of investment choices is another big difference between these plan types.
- A 401(k) plan often offers a much more comprehensive range of options, such as stocks, bonds, index funds, ETFs, etc.
- However, the 403(b) options are often much more limited. Typically, these accounts only allow investments in mutual funds and annuities.
When making your investment selections, you should consider your finances and consult a certified financial planner if you have any questions.
TIP
If your employer offers a Roth 403(b) or a Roth 401(k) retirement plan option, you should take advantage of this benefit. It will allow you to make more after-tax contributions than a typical Roth IRA. This will provide you with more retirement investments that can be withdrawn tax-free.
Choosing Between 403(b) And 401(k)
Sometimes, deciding between a 401(k) and 403(b) is easy. Depending on the type of employer for which you work, you may only have one choice.
If that is the case, then the choice is easy, and you should participate in that plan.
Sometimes, when choosing between a 401(a) and 401(k), you might have to dive into more detail. The choice can be a little more complicated if you can access both plans.
Since both plans offer many of the same benefits, you really cannot go wrong either way.
- A 401(k) usually comes with an employer match, which is not always true with 403(b) plans. This can help your retirement savings grow more quickly.
- On the flip side, the 403(b) allows you to make additional contributions to your account if you have been with your employer for 15 years or more.
When it comes time to decide, you should weigh your personal situation and discuss your long-term goals with your financial planner. There is no “one size fits all” solution, and your choice should be guided by your situation.
| Provisions | 401(k) Plan | 403(b) Plan |
|---|---|---|
|
Eligibility |
Any employer can sponsor these plans. Employers are are limited on the restrictions that can be placed on participation. |
Only educational employers and non-profits (recognized under 501(c)(3) can sponsor these plans. Empoyers have more flexibility to limit employee participation. |
|
Contribution Limits |
Employees may contribution $23,000 annually |
Employees may contribution $23,000 annually |
|
Catch-Up Contributions |
If employee is over 50, an additional $7,500 can be contributed annually. |
If employee is over 50, an additional $7,500 can be contributed annually.
Plus, if employed with same employer for 15 years, employee may contribute an additional $3,000 annually. |
|
Tax Implications |
Employee and employer contributions are tax-deferred (unless Roth option is selected).
Employer contributions are deductible for employer. |
Employee and employer contributions are tax-deferred (unless Roth option is selected). |
|
Investment Options |
More comprehensive range of options, such as stocks, bonds, index funds, ETFs, etc.
Chooses are limited by plan documents. |
Limited to mutual funds and annuities only. |
The Bottom Line
403b and 401k plans are great investment options, allowing you to grow your nest egg.
The plans are pretty similar, with only a few minor differences. Most of the major provisions are the same between the two.
Whichever plan you choose, you should try to contribute as much as possible to the plan so that you will be ready for retirement when the time comes.
Frequently Asked Questions
As with any investment, there is some risk associated with it. The value of your account may decrease as the markets fluctuate.
While these plans have historically provided good long-term returns, it is possible to lose money in them.
If you have any investment concerns, you should consult your financial planner to answer your questions and provide guidance.
First, if the person works for a school or non-profit, the 403(b) retirement plan might be their only option.
Next, they might choose the 403(b) if they plan to remain with their employer for many years. These plans allow for additional contributions after 15 years of service, so you can put even more tax-deferred dollars into your plan after reaching this milestone.
The other provisions of the 403(b) and 401(k) plans are pretty similar, so the 403(b) plan might be the right choice for some people.
The most an employee can contribute to their 403(b) for 2024 is $23,000. If that employee is 50 or older, they can contribute an additional $7,500 annually to the account.
Likewise, if an employee has been with their employer for 15 years or more, they can contribute another $3,000 to the plan. Employers can also provide matching funds to the account up to a maximum of $69,000 under regular circumstances.
So, considering all the possible catch-up contributions and matching funds, you can put away up to $79,500 in your 403(b) in a given year.
Neither plan is inherently better than the other. The two plans are very similar, and your choice might depend on what plan is offered by your employer.
There are only a few significant differences between the two, and both plans can help you put away tax-deferred savings for retirement.
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