403(b) vs. 401(k): What is the Difference?

Are you over the age of 50 and have been thinking about retiring? You’ll be happy to know that there are various investment options for you to choose from — more so if you’re up to date with paying taxes. But don’t delay beginning your retirement savings-the earlier you begin, the better your future years will be. 

In this blog post, we discuss the difference between a 403(b) vs. 401(k) and which one will be more suitable for you. 

Getting a 403(b) or 401(k)?

There are various retirement accounts to choose from, but the most common are the individual retirement account (IRA) and 401(k). These options provide more variations, such as the Roth IRA and the Roth 401(k). However, there are also lesser-known plans such as 403(b), which is generally known as 401(k)’s cousin.

Many people are unaware of these options, which can lead to questions, such as: How are they different from one another? How are they similar? Can anyone invest in a 403(b)? Let’s jump into the answers to these commonly asked questions. 

What is a 401(k) Plan?

As mentioned, the 401(k) is the most commonly used and the most well-known retirement plan. The 401(k) is a retirement plan sponsored by an employer where employees contribute to pre-tax earnings. An employer who offers a 401(k) can provide matching contributions to an employee’s 401(k) and can also add a profit-sharing feature to their plan.

A 401(k) plan is offered by private and for-profit companies. As of 2021, the annual contributions to 401(k)s have been limited to $19,500, with a catch-up bonus of $6,500 for employees that are 50 years and older. During your retirement, a withdrawal from a 401(k) will be subject to income taxes.

This is assuming that you didn’t pay taxes before contributing to a 401(k), where both the growth and the contributions accumulated in the account are taxed. Moreover, withdrawals taken before the age of 59½ will be subject to a 10% penalty tax from the IRS.

There are exceptions to this, however. If you decide to leave your job after turning 50, you may start taking some of your 401(k) contributions. A hardship withdrawal is also allowed, and won’t incur any additional penalties from the IRS. 

What is a 403(b) Plan?

When it comes to the 403(b) plan, those who can benefit from it include tax-exempt organizations, public school employees, and government employees, which includes:

●  Professors

●  Teachers

●  Librarians

●  Doctors

●  Nurses

However, this plan has a limited amount of investment options for either mutual funds or annuities. Another name for the 403(b) plan is the tax-sheltered annuity plan, which also offers features similar to those found in the 401(k) plan.

A 403(b) plan will have the same tax structure as a 401(k), where contributions made to a 403(b) can be taken from pre-tax earnings. Doing this will delay any tax obligations until your retirement. Just like in the 401(k), you will also have the same penalty tax, should you take any distributions before you turn 59½, or if you can’t present an eligible circumstance.

In terms of annual contribution limits, a 403(b) shares the same $19,500 amount as a 401(k). Moreover, a 403(b) participant older than 50 years can contribute another $6,500.

Similarities Between 401(k) and 403(b)

The 401(k) and a 403(b) are quite similar. Both serve as retirement accounts, using your pre-tax earnings as the contribution. Withdrawing from both accounts also has corresponding penalties unless there is an eligible reason or when you do so after 59½ years old. Furthermore, both implement the same IRS exceptions.

Both the 401(k) and 403(b) share a contribution limit of $19,500, as well as a catch-up bonus of $6,500. However, there are also differences between the two plans, which are discussed below.

Differences Between 401(k) and 403(b)

The key difference between 401(k) and a 403(b) is that 401(k)s are offered at for-profit companies, while 403(b)s are offered at non-profit organizations, as well as government agencies. In addition, 403(b)s only provide mutual funds as an investment option for their participants, while 401(k)s offer more choices, including:

●  Target-date funds

●  Index funds

●  Mutual funds

●  Bonds

To be more specific, a 401(k) plan can offer around 19 options for investment, on average. Additionally, a 403(b) plan will prominently feature annuities, while a 401(k) plan will provide a wide choice of index and mutual funds. This is because insurance companies are often behind 403(b) plans, while investment companies or mutual funds usually administer a 401(k).

Furthermore, 403(b) plans allow employers to match their employees’ contributions, but most won’t choose to do this so they don’t lose their ERISA exemptions. On the other hand, 401(k) plans provide employers the ability to match contributions, thanks to a much higher rate compared to 403(b) plans. Although, vesting occurs much faster through a 403(b) plan than a 401(k) plan, and many 403(b) plans offer immediate vesting for its participants.

Another difference is that 403(b) plans provide a catch-up bonus, which includes employees under 50 years of age. Additionally, employees who have worked at a company for at least 15 years may also begin their catch-up bonus at $3,000 every year. Keep in mind that these catch-up bonuses are capped at $15,000 throughout your lifetime in a 403(b) plan.

Although understanding the difference between a 403(b) and 401(k) may seem complicated at first, it’s important to know your options. Now that you’ve learned more about the difference between the two, you can rest assured knowing that you are well on your way to a comfortable retirement. Happy saving!