While there are many options for saving for retirement, one that you may not have heard of is a 403(b). It’s commonly referred to as the cousin to a 401(k). Both 401(k) and 403(b) are employer-sponsored retirement plans that allow you to contribute pretax dollars to your retirement savings. So what’s the difference? Let’s discuss 401(k) vs 403(b) below.
What is a 401(k) plan?
A 401(k) plan is an employer-sponsored retirement savings plan where employees can make tax-deferred contributions from their salary. Employers can offer a 401(k) as part of their benefits package and may match a portion of the employee’s contribution.
What is a 403(b) plan?
A 403(b) plan is a retirement savings plan for employees of nonprofits, public schools, tax-exempt organizations, and certain ministers. You can invest in either annuities or mutual funds.
What are the similarities between 401(k) and 403(b) plans?
- Both are typically tax deferred. You can contribute your pretax dollars which can decrease your taxable income and therefore may decrease your tax bill. Your money will grow tax-deferred until you are ready to withdraw it. When you withdraw the money then you will pay ordinary income taxes on the withdrawals.
- You generally must wait until you are 59½ to withdraw money from a retirement plan without penalty. If you do withdraw early then you may need to pay a 10% penalty, as well as state and federal income taxes.
- You must begin to withdraw from these accounts at age 72. The required minimum distribution age for both 401(k) and 403(b) plans is 72.
- Both types of accounts have the same annual contribution limits. The 2022 contribution amount for 401(k)s and 403(b)s is $20,500, or $27,000 if you are aged 50 or older. Your contribution amount cannot exceed your total income.
How are 401(k) and 403(b) plans different?
While these plans are quite similar, there are some differences that you need to be aware of.
- The type of employer: The main difference is the type of employer that offers them. 401(k)s are offered by for-profit public sector companies. 403(b)s are offered by nonprofits, churches and certain government agencies such as public schools and universities.
- Investment choice: 401(k)s are generally a mix of mutual funds, stocks, bonds, and other securities. Your company may also offer company stock. Assets in a 403(b) are generally annuities and mutual funds.
- Additional contributions: While the annual contribution limits are the same, some 403(b) plans allow an additional contribution of $3,000 per year if an employee has worked for that organization for at least 15 years.
- Higher fees: 403(b)s generally charge higher fees than 401(k)s. Costs do vary from plan to plan so make sure you look to see what fees they charge.
- Employer match: While both plans do allow for employer matching, fewer employers offer matches with their 403(b). The reason for this is that when they do offer 403(b) matching, they must comply with ERISA.
- ERISA compliance: 403(b) plans do not have to comply with the Employee Retirement Income Security Act (ERISA). However, if employers do offer a contribution match, they lose the ERISA exemption.
Comparison of 401(k) vs 403(b)
|What is it?||An employer-sponsored retirement savings plan for non-profit entities||An employer-sponsored retirement savings plan for any business entity, including non-profits.|
|Eligible employer||Educational organizations and nonprofit organizations under 501(c)(3) of the IRC||Any employer|
|Investment options||Annuities and mutual funds||Any investment available under the plan|
|Tax Treatment||Contributions are made pre-tax and grow tax-deferred||Contributions are made pre-tax and grow tax-deferred|
|Contribution Limits||Employees can contribute up to $20,500 for 2022 (or $27,000 if aged 50 and older). An employee of a “qualified organization” with 15 years of service may be eligible to contribute an additional $3,000 per year.||Employees can contribute up to $20,500 for 2022 (or $27,000 if aged 50 and older).|
|Deductions and deferrals||Employer contributions are tax deferred for employees. Employee contributions can be pre-tax or tax deferred.||Employer contributions deductible to the employer. Tax deferred for employees. Employee contributions can be pre-tax and tax deferred.|
|Subject to ERISA||Yes if considered an “employee benefit plan.” Employers often don’t provide employer contributions to the plan to remain exempt from ERISA.||Yes|
|Form 5500 annual reporting||If a non-ERISA plan, then a form 5500 is not required. If ERISA plan, then a form 5500 is required.||Required|
What are the contribution limits for 403(b) and 401(k) plans?
The 2022 contribution limit for both 403(b) and 401(k) plans is $20,500, or $27,000 if you are aged 50 and older.
Is a 403(b) better than a 401(k)?
Both are solid retirement savings vehicles that offer tax advantages and investment options. One is not necessarily better than the other. The type of retirement plan that you are eligible for is dependent on your employer, so you don’t generally get to choose between a 403(b) or a 401(k).
Can I contribute to a 403(b) and a 401(k)?
While it is rare for employers to offer both a 403(b) and a 401(k), it is possible. If this is the case, then you can contribute to both. However, you would still be subject to the $20,500 contribution limit combined between the two accounts.
Start saving for retirement today!
401(k) and 403(b) plans are similar and the decision will typically come down to what is offered by your company. The important thing is to take advantage of your employer’s retirement plan and start saving for retirement today. It’s a simple, effortless way to save for retirement. If you want help with your finances and are interested in having a comprehensive financial plan for your family, feel free to schedule a discovery call with one of our financial advisors today!
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.