What's the difference between a 401(k) and a 403(b)?
401(k)s and 403(b)s are very similar. However, 401(k)s are provided by for-profit companies and 403(b)s are for non-profit and government employees.
There are many different retirement vehicles from which to choose. The most common are the 401(k) and IRA. Within those are variations such as the Roth 401(k) and the Roth IRA. However, many haven’t heard of the 403(b), the cousin to the 401(k). So what’s the difference between a 401(k) and a 403(b)? Can anyone invest in a 403(b)?
A 401(k) and a 403(b) are very similar. Both are retirement accounts and use pre-tax earnings as contributions. The withdrawals from both accounts are subject to the same penalties unless done so after 59½, with the IRS exceptions applying to both 401(k)s and 403(b)s. The contribution limit for 401(k)s and 403(b)s is $19,500. The main difference between a 401(k) and a 403(b) is that for-profit companies offer 401 (k)s, and 403(b)s are offered to employees of non-profit organizations and the government. Also, 403(b)s only offer mutual funds as investment options for its participants, whereas 401(k)s over an array of mutual and index funds, target-date funds, and bonds.
The most common of the retirement plans is the 401(k). A 401(k) is an employer-sponsored retirement plan that employees make contributions from their pre-tax earnings. Employers offering a 401(k) plan can make matching contributions to a 401(k) and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan are also tax-deferred. 401(k) plans are offered through private, for-profit companies.
Annual contributions to 401(k)s are limited to $19,500 in 2021, with an additional $6,500 catch-up bonus for those 50 and older.
Withdrawals from a 401(k) during retirement are subject to income taxes. Since the employee didn’t pay taxes prior to contributing to a 401(k), both contributions and the growth the account accumulated are taxed.
Withdrawals taken earlier than 59½ are subject to the IRS’s 10% penalty tax. However, there are exceptions. If an employee leaves their job after 50, they can begin taking distributions from their 401(k). Hardship withdrawals are also exempt from any additional IRS penalties.
A 403(b) plan is a retirement plan for employees, tax-exempt organizations, and government employees such as teachers, professors, government employees, nurses, doctors, and even librarians. These plans are limited in investment options to either annuities or mutual funds. A 403(b) plan is also another name for a tax-sheltered annuity plan, and the features of a 403(b) plan are comparable to those found in a 401(k) plan.
403(b) plans are subject to the same tax structure as 401(k)s. Contributions to 403(b)s are made with pre-tax earning, thus, delay tax obligations until retirement. Additionally, the same penalty tax is applied to distributions taken before 59½ or without eligible circumstances.
The annual contribution limit of $19,500 applies to 403(b)s as well. 403(b) participants who are older and 50 can also contribute an additional $6,500.
The Differences Between 401(k)s and 403(b)s
With all of the similarities between the two retirement accounts, there are some key differences to be aware of.
While 403(b) plans are eligible to provide employer matches to their employees’ contributions, most employers are don’t offer to match contributions, so they do not lose ERISA exemptions. In contrast, 401(k) plans provide an employer match at a far high rate than 403(b) plans.
However, vesting occurs much quicker with 403(b) plans than with 401(k), with many 403(b)s offering immediate vesting to its employees.
Additionally, 403(b) plans offer an additional catch-up bonus for employees even if they are under 50. Employees who have been with a company for 15 years can begin making catch-up bonuses of $3,000 per year. Catch-up bonuses towards 403(b)s are capped at a $15,000 lifetime amount.
Lastly, the investment options vary significantly between 401(k)s and 403(b)s. While 401(k)s offer about 19 different investment options on average, 403(b) offer only a few mutual funds that participants can choose from. 403(b) plans prominently feature annuities, while 401(k) plans tend to offer an array of mutual and index funds. This is because insurance companies often administer 403 (b) plans, whereas 401(k)s are usually administered by mutual fund or investment companies.