What’s the Difference Between a 401(k) and 403(b)?


Saving for retirement seems like a long-term plan, but it’s essential to understand the nuances of your investments right from the start. If you work for a company offering employee plans, you may have heard of either a 401(k) or a 403(b) — or maybe both.

couple investment planning

While there are several similarities between the two, there are also significant differences in which one you can qualify for and how your savings are impacted.

Find out which plan is right for you and how you can maximize your contributions so that you’re well-prepared for retirement when the time comes.

What is the difference between a 401(k) and a 403(b) retirement plan?

Both 401(k) and 403(b) are named after sections of the IRS tax code. The biggest difference between these two plans is actually your employer. 401(k) plans are generally used in the private sector. 403(b) plans, on the other hand, are designed to help public sector organizations save money with administrative costs. Let’s take a look at how these two types of plans work and how you can qualify for one of them.

Enrollment Qualifications

To qualify for a 403(b), you need to work for an eligible employer, such as a government entity, non-profit organization, or religious organization. Since these entities don’t generally have budgets as flexible as those of a for-profit company, a 403(b) helps them cut back on administrative costs so the employees can prepare for retirement. For-profit companies usually use 401(k)s as an employee benefit instead of a 403(b).

For both types of retirement plans, income tax is deferred until you actually start taking withdrawals. That means the contributions you make are deducted from your taxable income each year. This will help you save on your tax obligations.

With both a 403(b) and a 401(k) you can start withdrawing funds penalty-free when you turn 59 ½. Before that, you can still access your money. However, you’ll have to pay a 10% penalty fee on top of income taxes.

Administrative Costs

One of the differences between a 403(b) and a 401(k) is the administrative costs associated with each plan. The details on this information may not be readily available and won’t impact you directly. However, these costs can influence how and what you’re charged.

Even if you have a plan that makes it easy to automate your investments, you still need to compare the costs involved. You can’t pick and choose between a 403(b) and a 401(k). But, you can make sure the investments themselves aren’t costing you more than they should. Over the course of a couple of decades, extra fees can really add up and take a lot out of your retirement savings.

The best course of action is to access information on the fees you’re being charged for your account. If they’re not listed on your statement, then you may have to call the company managing your plan. Your human resources department is a good resource for pointing you in the right direction to learn more.

Because a 403(b) is specifically designed for non-profit organizations and government agencies, your fees may be lower. On the downside, your employer may not be very involved in the plan’s administration. There are fewer regulations associated with a 403(b). So, it’s important that you pay careful attention to how you’re investing and being charged.

Contribution Limits on Elective Deferrals

Both a 401(k) and a 403(b) come with limits on how much you can contribute each year. For 2021, the maximum elective deferral amount is $19,500. That means you personally cannot contribute more than that with tax-deferred income for both these kinds of retirement vehicles.

If you’re old enough, though, you can play a bit of catch up.

For taxpayers who turn 50 by the end of the year, you can contribute an additional $6,000 per year into either your 401(k) or 403(b). There’s also an additional way to save that’s exclusive to those with 403(b) plans.

If you have at least 15 years of service with your employer, you can contribute another $3,000. The catch, though, is that you can only contribute a total of $15,000 under this service limit. Once you hit that number, you can no longer make these “catch-up” contributions.

Potentially, then, your maximum allowable contribution with a 403(b) could be $21,000 per year, or up to $27,000 if you’re 50 years or older. While this service rule is allowed by the IRS, it’s not required that your employer offer the extra benefit. If you want to take advantage, first make sure that it’s included in your plan.

Employer Contributions

Some employers offering either type of retirement savings plan may offer an employer match. Usually, it’s structured as a percentage of your pay. For example, your employer may match your 403(b) or 401(k) contributions up to 3% of your salary. If you earn $80,000 a year and contribute $2,400 to your plan (that’s 3%), then your employer would pay that much on your behalf.

It’s basically like free money so it’s smart to invest at least the maximum match amount. This employee benefit is more common with 401(k)s, though it’s certainly possible to have a matching policy with a 403(b).

With employer matching, be aware that you may have to be vested in the company for a certain period of time before you can actually access those matched funds. That means if you leave either voluntarily or involuntarily before the pre-determined vesting period, you won’t get to keep your employer-matched funds.

Private companies offering 401(k)s generally have stricter vesting requirements. If you do have an employer match with your 403(b) you may not have to wait as long to secure those funds permanently in your retirement account.

Investment Options

Generally speaking, a 401(k) plan generally has more investment options available than if you have a 403(b). You’ll usually have access to at least some mutual funds and ETFs, as well as company stock if applicable. In some cases, you may even get to choose from the entire available investment options from the program administrator. If, for example, your 401(k) is managed through Vanguard, you may get to select from some of their products.

403(b) plans, on the other hand, generally have limited access to a selection of mutual funds or annuities. Annuities can be a bit tricky in some cases, so exercise some caution here. These are contracts with an insurance company that pays either fixed or variable payments on your investment growth. The contract may also provide for a death benefit paid to the beneficiary.

If the annuities plan includes incidental life insurance, your contributions as an employee may not be 100% tax-deductible. The money paid for that policy can be included on your W-2 as part of your taxable wages. So you may not necessarily get the most out of your plan if you choose the annuity route with a 403(b). Make sure you read all of the terms and conditions before you make a decision.

Diversify to Minimize Risks

No matter which plan you have, remember to diversify your investments in order to minimize the potential for risk. As you get older, revisit your investments to make sure they still make sense. You should always keep track of how your investments are faring on a regular basis. An annual review is also a good idea to make sure you’re utilizing the right degree of risk management.

The older you get, the more conservative investments you should be choosing. With many retirement plans, you can get some kind of guidance on how to allocate your contributions, usually through an automated platform with recommendations.

Withdrawing Funds

When it comes time to start making withdrawals from your retirement account, 401(k) and 403(b) plans primarily act the same way. Any withdrawals made before you turn 59 ½ incur a 10% penalty. No matter when you start taking out funds, that money will also be subject to income tax since they are both tax-deferred accounts.

You’re not actually forced to take out money until you reach the age of 70 ½. At that time, you must start taking a required minimum distribution (RMD). Otherwise, that amount is taxed at a rate of 50%. That’s definitely some strong incentive to follow the rules on RMDs. The only slight variation with 403(b)s is that contributions make before 1987 don’t have to be withdrawn until you reach age 75.

Taking Out a Loan

Another withdrawal option with both a 401(k) and 403(b) is taking out a loan against your funds. You can borrow up to 50% of your plan’s value, which must be repaid within a five-year period. The maximum loan amount is $50,000.

There’s an exception if you use the money to buy a home, in which case you can repay the funds over a longer period. Again, while the IRS allows for this type of loan against your retirement plan, it still needs to be offered by your employer. It’s not required that their 401(k) or 403(b) plan actually includes this type of loan product.

Is a 403(b) plan better than a 401(k)?

You generally can’t choose which plan you get since your employer determines the retirement savings plans that are available to employees. No matter which one you have, check out the investment options available and be sure to consider the expense ratios. A fund that is more actively managed can really take a toll on your retirement savings because the fees add up so much over time.

If you have a 403(b) and are nearing or have already worked for the employer for 15 years, check with your employer to see if you can increase your maximum allowable contribution. You could definitely put some new life into your retirement savings, especially if you still have several years left before you plan to retire.

Can you roll a 403(b) into a 401(k)?

There are a couple of different instances when you can roll over your 403(b) into a 401(k) plan. The most common is if you switch jobs and your new employer offers a 401(k). The IRS allows you to roll your 403(b) funds into that account without any type of penalty or taxation. The opposite scenario also holds true. You can move your existing 401(k) funds into a 403(b) if that’s the plan your new employer offers.

Another time when rollovers are allowed is when you become self-employed and open an independent 401(k). You’re absolutely allowed to transfer those funds to another tax-deferred account. In actuality, rollovers aren’t just limited to 401(k) and 403(b) plans. You can also move those funds into a traditional IRA or Roth IRA.

The only difference is that since Roth IRAs are not tax-deferred plans, you will need to pay tax on those funds during the rollover. You won’t, however, be subject to the 10% withdrawal penalty. Of course, when you start taking withdrawals from a Roth IRA, you don’t pay tax at that time. A traditional IRA is tax-deferred, so the rollover process is treated the same as a 401(k) rollover.

Bottom Line

While there are quite a few similarities between a 401(k) and 403(b), there are also some stark differences. If you find yourself moving to a job where a different plan is offered than the one you’re used to, make sure you understand the key differentiators. Also, take a look at your rollover options so that you can manage your retirement accounts with ease.

Lauren Ward
Meet the author

Lauren is a Crediful writer whose aim is to give readers the financial tools they need to reach their own goals in life. She has written on personal finance issues for over six years and holds a Bachelor's degree in Japanese from Georgetown University.