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


Retirement planning is an integral part of personal finance. With a myriad of options available, understanding the ins and outs of different retirement plans can seem overwhelming.

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Two of the most common are the 401(k) and 403(b) plans. These tax-advantaged retirement plans are widely used, but each has distinct features, benefits, and rules. This article will help illuminate the similarities and differences between these two options.

What is the difference between 401(k) and 403(b) accounts?

Both 401(k) and 403(b) are named after sections of the IRS tax code. The most significant difference between these two plans is who your employer is. 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 on administrative costs. Let’s take a look at how these two types of plans work and how you can qualify for one of them.

Understanding Employer Retirement Plans

A retirement plan is an arrangement that allows an individual to set aside funds for use during retirement. Retirement accounts come in various forms, each with their own rules and benefits. The primary goal of these accounts is to provide a steady stream of retirement income once your working years are over.

Employer-sponsored retirement plans, such as the 401(k) and 403(b), are popular because they offer tax advantages and often include matching contributions from the employer. The features of these plans can be complex, so let’s take a closer look.

An Overview of 401(k) Plans

Named after a section of the tax code, the 401(k) plan is a type of employer-sponsored retirement plan primarily offered by for-profit companies. The 401(k) allows employees to make pre-tax contributions directly from their salary, reducing their taxable income for the year. These contributions, and any earnings from them, grow tax-deferred until retirement.

The 401(k) plans have annual contribution limits, which are adjusted periodically by the IRS. As of this writing, the contribution limit is $19,500, with an additional $6,500 in catch-up contributions allowed for those aged 50 and over.

Many employers offer matching contributions, providing an extra boost to your retirement savings. For instance, an employer might match 50% of employee contributions up to a certain percentage of their salary.

One of the key benefits of 401(k) plans is the variety of investment options they typically offer. These often include a range of mutual funds, such as stock and bond funds. But remember, investing involves risk and it’s important to understand that past performance is not indicative of future results.

Withdrawal rules for 401(k) plans are generally strict. While you can withdraw money from your 401(k) at any time, withdrawals before retirement age (currently 59½) usually incur a 10% penalty in addition to ordinary income taxes.

An Overview of 403(b) Plans

The 403(b) plan, also known as a tax-sheltered annuity plan, is another type of employer-sponsored retirement plan. Unlike 401(k) plans, 403(b) plans are typically available to employees of tax-exempt organizations, such as non-profit organizations, public schools, and government agencies.

Just like a 401(k), contributions to a 403(b) plan are made pre-tax, reducing the employee’s taxable income. The annual contribution limit and catch-up contribution rules for 403(b) plans are the same as those for 401(k) plans.

Many 403(b) plans offer mutual funds as investment options, but some also offer annuities. Annuities are contracts with insurance companies that promise to pay a specific income in the future in exchange for contributions now.

When it comes to withdrawal rules, the 403(b) is similar to the 401(k). Early withdrawals usually come with a 10% penalty, plus income tax on the amount withdrawn.

Key Differences between 401(k) and 403(b) Plans

While 401(k) and 403(b) plans share many similarities, there are several key differences.

First, the types of employers that offer these plans differ. While 401(k) plans are commonly offered by for-profit companies, 403(b) plans are typically available to employees of nonprofit organizations and government agencies.

Second, 403(b) plans often have fewer investment options compared to 401(k) plans. While both typically offer mutual funds, some 403(b) plans also provide annuities as an investment option.

Next, the administrative costs of 403(b) plans are typically lower than those of 401(k) plans. This is primarily due to the 403(b) being subject to fewer administrative requirements, which can lead to lower fees for participants.

Another key difference lies in employer matching contributions. While many employers offer matching contributions for both types of plans, government employers and non-profit organizations may be less likely to match employee contributions due to budget constraints.

Lastly, while both plans allow for loans, the provisions can vary. Both permit borrowing of up to 50% of the vested account balance or $50,000, whichever is less, but the specifics may differ depending on the plan’s rules and regulations.

Similarities between 401(k) and 403(b) Plans

Despite these differences, 401(k) and 403(b) plans have many similarities. Both are tax-advantaged retirement plans that offer significant tax benefits. Contributions are made pre-tax, reducing the contributor’s taxable income for the year. In addition, you won’t pay income taxes on the earnings until you withdraw them in retirement.

Both 401(k) and 403(b) plans have the same annual contribution limit. As of this writing, the limit is $19,500, with an additional $6,500 in catch-up contributions allowed for those aged 50 and over.

Furthermore, both plans have strict rules regarding withdrawals. Generally, you can’t withdraw money before age 59½ without paying a 10% penalty in addition to ordinary income tax. After age 70½, you must start taking required minimum distributions (RMDs) from these plans.

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

You typically 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, have a look at 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 plan because the fees add up so much over time.

When you reach, or if you’ve already reached 15 years of employment with an employer, check with the employer to see if your maximum contribution can be increased. You could definitely put some new life into your retirement accounts, 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 taxes 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 grows tax-deferred, so the rollover process is treated the same as a 401(k) rollover.

Choosing the Right Plan for You

Choosing between a 401(k) and a 403(b) is largely dependent on your occupation and the type of employer you have. If you work for a for-profit company, you’re likely to have access to a 401(k), while employees of non-profit organizations and government employers often have access to a 403(b).

Beyond availability, your choice should also be influenced by your financial goals, risk tolerance, and the specific features of the plan, including employer matches, investment options, and fees.

While this guide provides a basic understanding of these plans, the nuances can be complex. You may want to consult with financial advisors, such as a certified financial planner or a registered investment adviser, who can provide personalized advice based on your individual circumstances.

Bottom Line

Both 401(k) and 403(b) plans are powerful tools for retirement savings. They offer tax advantages, potential employer contributions, and a range of investment options. Whether you have access to a 401(k) or a 403(b) largely depends on your employer, but either way, these plans can form a crucial part of your retirement savings plan.

Remember, investing involves risk and it’s essential to understand your risk tolerance and financial goals before deciding on a plan. Consult with a professional if you’re unsure, and always remember that past performance is not a guarantee of future results.

As you plan for your future, keep in mind that savings for retirement are meant to provide income in your later years. Make the most of these tax-advantaged options, and you’ll be well on your way to a comfortable retirement.

Lauren Ward
Meet the author

Lauren is a personal finance writer who strives to equip readers with the knowledge to achieve their financial objectives. She has over a decade of experience and a Bachelor's degree in Japanese from Georgetown University.