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403(b) Plan vs. 401(k) Plan: What’s The Difference? | (Full Guide) Inside


Old Couple Standing On Top Of Coins Retirement Planning ConceptWhen it comes to retirement planning, all the options available out there can get confusing. There are many plans out there, but do you really know the difference between a 401k, 403b, 457b, 401a, and all the others? You are not alone as most people have trouble when it comes to comparing all the different retirement plans that might be available. Luckily, we are here to help! If you are choosing between a 403b vs 401k, then you are in the right place. We will tell you everything that you need to know about both plans as well as the key differences between the two. Keep reading to learn more about these two plan types.

What Is A 403(b) Retirement Plan

A 403(b) plan is considered a defined contribution plan. These plans are recognized by the IRS and provide certain tax benefits, although they may not may not be considered qualified retirement plans depending on whether your employer makes contributions to your plan. Your contributions into the plan are made on a tax-deferred basis. This means that your taxable income in the current year is reduced by the amount of your contributions into the plan. That money is not taxed in the current year. Rather, the money gets invested in the retirement account and grows tax-free until you reach normal retirement age. When you begin taking withdrawals from the account, then you will pay normal income taxes on that money.

403b plans are typically offered to employees of public schools and universities as well as some non-profit organizations like churches. Like many other retirement accounts, a 403(b) plan has an annual contribution limit. For 2021, that limit is $19,500. Your employer may decide to make matching contributions to your plan. In that case, your total contribution including both employee and employer contributions cannot exceed $58,000. You are also entitled to catch up contributions of $6,500 per year after reaching age 50.

When it comes to withdrawals, a 403b plan is fairly standard. You can begin taking withdrawals penalty-free upon reaching age 59 1/2. If you withdraw your funds before reaching this age, then you will pay an additional 10% penalty in addition to regular income taxes on the funds.


How Does A 401(k) Work

The 401k plan is probably one of the most common types of retirement accounts in the private sector. It functions very similarly to a 403b plan. These accounts are considered defined contribution plans, and they are also qualified retirement plans according to the IRS because they are protected by the Employee Retirement Income Security Act (ERISA). Employees can make tax-deferred contributions into 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 $19,500 per year into his or her 401k with additional catch up contributions of $6,500 per year after age 50. The employer match is a big plus to the 401k as many for-profit companies offer matching funds to help their employees grow their retirement savings.

If you need to withdraw money from your 401k, then you can expect to pay an early withdrawal penalty if you do so before age 59 1/2. The standard 10% penalty will apply in this case. Most 401k plans have a vesting period. This means that you might lose some of your employer’s matching funds if you leave the company before you are 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 with no penalty, although you should check your plan documentation for specifics. Upon reaching age 72, you will be forced to take required minimum distributions (RMD’s) from your account.


403(b) VS 401(k): Key Differences

So, what is the difference between a 401k and 403b? At the very basics, these two plans are quite similar. Many of the key provisions between the plans are the same, although there are a few important differences. Here we will look at both the similarities and differences between these plans in a few major areas.


Eligibility Rules

This is one of the main differences between the two plans. A 401(k) plan may be offered by any employer, 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, but they cannot exclude those who are over age 21, have over 1 year of service and work over 1,000 hours per year.

A 403b, on the other hand, can only be offered by educational institutions and tax-exempt organizations. All employees are eligible to participate, but the employers may limit their participation rules more tightly than with a 401k. This applies to both government employers and non-profits.


Contribution Limits

Contribution limits into these plans for employees is roughly the same. Each plan allows for contributions up to $19,500 per year with additional catch up contributions of $6,500 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 $58,000. 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.


Tax Consequences

Again, the tax consequences with these plans are nearly identical. The contributions into 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 can be taken tax-free when they are made from a Roth 401(k) or Roth 403(b). 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.


Early Withdrawal Rules

As with most retirement savings plans, you will pay an early withdrawal penalty in both a 401k and 403b if you withdraw funds before reaching age 59 1/2. A 10% penalty will be assessed on the amount of funds withdrawn. In some cases, your plan sponsor may allow loans from your plan without a penalty. This is an employee benefit provided by some employers, but they are not required to allow plan loans. Both plans allow for rollovers into an IRA or Roth IRA without penalty, but a 403b plan probably does not make you eligible for a mega backdoor Roth.


Investment Options

The range of investment choices is another big difference between these plan types. A 401k plan often has a much wider range of options like stocks, bonds, index funds, ETF’s, and other choices. However, the options for a 403b are often much more limited. Typically, these accounts only allow investments in mutual funds and annuities. You should consider your personal finances when making your investment selections, and you should consult a certified financial planner if you have any questions.



401K Plan VS 403b Plan
  401k Plan 403b Plan
Eligibility Any employer can sponsor plan

Employer can place minimal restrictions on participation

Educational employers and non-profits recognized under 501(c)(3)
Contribution Limits Employee may contribute up to $19,500 per year.

Additional catch up contributions of $6,500 per year if employee over age 50.

Same $19,500 and $6,500 catch up as 401(k).

If employee with same employer for 15 years, may contribute an additional $3,000 per year.

Tax Implications Employee and employer contributions are tax-deferred.

Employer contributions are deductible for employer.

Employee and employer contributions are tax-deferred.
Investment Options Wide range of options.

Can invest in any options available through plan documentation.

Mutual funds and annuities only


Choosing Between 403(b) And 401(k)

Sometimes, the decision between a 401k vs 403b 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, like when choosing between a 401a and 401k, you might have to dive into more detail. If you have access to both plans, the choice can be a little more difficult.

Since both plans offer many of the same benefits, you really cannot go wrong either way. However, a 401k usually comes with an employer match more frequently. This can help your retirement savings grow more quickly. On the flip side, the 403b allows you to make additional contributions into 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.


The Bottom Line

Both 403b and 401k plans are great investment options that allow you to grow your nest egg. The plans are quite similar with only a few minor differences. Most of the major provisions of the plans are the same between the two. Whichever plan you choose, you should try to contribute as much as possible into the plan so that you will be ready for retirement when the time comes.


Frequently Asked Questions

Can you lose money in a 403b?

As with any investment, there is some risk associated with investing. It is possible for the value of your account to decrease as the markets fluctuate. While these plans have historically provided good returns over the long-term, it is possible to lose money in these plans. If you have any concerns about investing, then you should consult your financial planner to answer your questions and provide guidance.


Why would someone choose a 403b over a 401k?

First, if the person works for a school or non-profit, then the 403b retirement plan might be their only option. Next, they might decide to choose the 403b if they plan to remain with their employer for many years. These plans allow for additional contributions into the plan after 15 years of service, so you can put even more tax deferred dollars into your plan after reaching this milestone. Most of the other major provisions between a 403b and 401k are the same, so the 403b might be the right choice for some people.


What is the maximum amount of money you can put into a 403b?

The most that an employee can contribute to their 403b in 2021 is $19,500. If that employee is age 50 or older, then they can contribute an additional $6,500 per year into the account. Likewise, if that employee has been with their employer for 15 years or more, then they can contribute another $3,000 into the plan. Employers can also provide matching funds into the account up to a maximum of $58,000 under regular circumstances. So, considering all the possible catch up contributions and matching funds, it is possible to put away up to $67,500 into your 403b in a given year.


Is a 403b better than a 401k?

Neither plan is inherently better than the other. The two plans are very similar, and your choice might simply depend on which plan your employer offers. There are very few major differences between the two, and both plans can help you put away tax-deferred savings for retirement.