There are many different retirement savings vehicles to choose from, but some of the most powerful and common vehicles are provided by an employer, such as 401k and 403(b) plans. You may be wondering what the difference is between 401k and 403(b) plans. The main difference between a 401k and a 403(b) is the type of employer that can offer these plans; 403(b) plans are mainly offered by non-profits.
The good news is that for most employees, there is very little practical difference between the two plan types. In this article, we’ll take a look the key similarities and differences between 401k and 403(b) plans.
One of the most common investment vehicles, a 401k is a tax-advantaged, employer-sponsored plan that allows you to save for retirement in a tax-sheltered way to help maximize your retirement dollars. Sometimes, your employer may even contribute to your plan.
Read More: What is a 401k? – A Comprehensive Guide
401k plans have traditionally been offered only by private, for-profit companies, though this has started to change in recent years.
403(b) plans, sometimes called tax-sheltered annuities (TSAs), are retirement plans offered by tax-exempt 501(c)(3) non-profits, including public school systems and certain ministries. Plan participants can include teachers, school administrators, professors, government employees, nurses, doctors, librarians, and clergy.
Read More: Types of Retirement Plans for Individuals
Contribution and Withdrawal Similarities
Both 401k and 403(b) plans are tax-advantaged retirement vehicles offered by employers. There are a number of methods for funding, and the one most people are familiar with is deferral into the plan directly from your paycheck. 401k and 403(b) plans have the following deferral limits:
- Employees can contribute up to a maximum amount of $19,500 in 2021, and $20,500 in 2022
- For workers ages 50 and older, the contribution limit increases by $6,500, both in 2021 and 2022
1. Employer Contributions
Some 401k and 403(b) plans are designed to allow the employer to make contributions as well. These can take the form of employer lump sum contributions at various intervals or matching where the employer contributes a certain amount on top of your own deferral.
2. Tax-Advantaged Accounts
Both 401k and 403(b) plans offer tax-deferred growth, meaning contributions within the accounts are not taxed over time as they grow. All 401k and 403(b) plans offer a pre-tax deferral option where your contributions are made income tax-free, and employer contributions are always made on a pre-tax basis. Distributions of pre-tax funds from the account someday are taxed as ordinary income. Some plans also offer a Roth option where contributions are taxed as ordinary income when deferred into the plan, with future withdrawals that are totally tax-free as long as you follow all the rules. Check with the plan administrator to learn more about your contribution options.
3. Withdrawal Rules
401k and 403(b) plans share mostly similar rules around withdrawals. Generally, you’re not able to take a withdrawal from either plan type while still employed at the company until reaching age 59 ½, though there are certain IRS exceptions. If you do take a withdrawal before age 59 ½ and don’t qualify for one of the IRS exceptions, you could be assessed a 10% penalty in addition to income taxes. Some 401k and 403(b) plans offer a loan option where tax-free withdrawals can be made, though this is contingent on making payments back into the plan until the loan is paid off. Distributions are required in most cases from both plans once you reach age 72. We recommend working with your tax and financial advisors before taking any early withdrawals out of your retirement accounts.
Read More: When Can You Withdraw From Your 401k or IRA Penalty Free?
Differences between 401k and 403(b) Plans
As I mentioned previously, the main difference between the two is the employer sponsoring the plans: 401k plans are offered by private, for-profit companies, while 403(b) plans are only available to nonprofit organizations and government employers. In addition to the employer demographics for both retirement accounts, 401k and 403(b) plans can have varying costs and investment choices.
1. Employer Match
Although both plans allow for employer matching, fewer employers offer contributions to their employees’ 403(b) plans. That’s because if an employer who offers a 403(b) does offer a match, they have to comply with regulations created by the Employee Retirement Income Security Act (ERISA), which governs employer-sponsored, tax-deferred retirement investments, including 401ks and 403(b)s.
Another difference is that for non-ERISA 403(b) plans, expense ratios can be much lower since they undergo less stringent reporting requirements.
So even though 403(b) plans are legally able to provide employer-matched funds, most employers do not so they do not lose ERISA exemption.
2. Investment Options and Cost
Some 403(b) plans offer an extra catch-up savings provision of $3,000 for longtime employees of the organization. This can turn into a significant extra savings option, so check with your plan administrator to learn if your plan allows this special treatment.
Depending on the investment options offered in your 401k or 403(b) plans, the fees and costs you end up paying may be low or high. In some cases, fees and administrative costs can be higher with some 403(b) plans since non-profit organizations and other qualifying entities may be smaller than private, for-profit companies. 403(b) plans are also more likely to have expensive mutual funds and annuities in their list of available investment options, whereas 401k plans may present more variety through lower-cost index funds and ETFs.
Which is Better for Retirement?
Both 401k and 403(b) plans are powerful savings vehicles, especially if the employer makes contributions. One is not necessarily better than the other. Also, most employees don’t have a choice of which plan to use, so the most important thing to focus on is diligent, disciplined savings over time to pursue your long-term financial goals.
The Bottom Line
Preparing for retirement is part of your overall financial plan. You can take a few actions now to get yourself on the right track.
- Download 65 Ways to Retire Smart, an actionable guide with insights from fiduciary financial advisors. The guide is free.
- Sign up for the Personal Capital Dashboard. Millions of people use these free and secure professional-grade online financial tools. You can use them to see all of your accounts in one place, analyze your spending, and plan for long-term financial goals.
- Consider talking to a fiduciary financial advisor for more detailed guidance on your retirement saving strategies.
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