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403(b) vs 401(k): What’s the Difference?
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Last Updated on: 11th July 2022, 03:08 pm
Let’s take a look at the difference between 403b vs 401k retirement plans. Both retirement accounts are tax-advantaged plans offered by an employer. If you are wondering which one you should choose, know that you don’t get to choose. The plans are offered depending on the status of the employer.
Non-profit organizations and some government employers offer their employees 403(b) plans, while for-profit organizations offer 401(k) plans. For both plans, you can choose whether you make traditional contributions or Roth contributions.
With traditional contributions, you make untaxed payments to your plan, and you pay income tax when you take withdrawals. Under a Roth plan, you make taxed contributions to your plan but pay no taxes when you retire. Both plans allow your investments to grow tax-free.
What Is a 403(b) Plan?
403(b) plans are retirement plans for certain employees of non-profit organizations, government employers, and some ministers. A 403(b) plan is also known as a tax-sheltered annuity plan. However, the features of a 403(b) are similar to those of a 401(k).
Examples of employees of tax-exempt employers that can participate in a 403(b) plan include:
- School teachers
- University professors
- Public administration staff
- Local town hall employees
403(b) plans may allow matched contributions to be vested in a shorter time than 401(k) plans. And some 403(b) plans allow for those sums to be vested immediately. However, there are some restrictions to 403(b) plans not present with 401(k) plans. We'll look at those restrictions further down.
What Is a 401(k) Plan?
401(k)s are qualified employer-sponsored retirement plans where you can make pretax or after-tax contributions from your salary. Your employer will deduct the contributions directly from your pay slip. The employer may also make voluntary matching or non-elective contributions to your plan.
In general, you will pay taxes on your distributions from a traditional 401(k) depending on your tax bracket at the time of retirement. However, the taxes you will pay may vary depending on which type of plan, and how and when you withdraw your funds.
Your employer may also add a profit-sharing plan feature to your 401(k). In either case, you pay taxes on your distributions much as you do on your paycheck. Of course, Roth 401(k)s do not pay income tax on distributions.
403(b) vs 401(k): Legal Differences
One of the main differences between 403(b) vs 401(k) plans are reporting requirements. As long as the employer does not make matching contributions, they are not considered employer-sponsored.
By not making matching contributions 403(b) providers avoid ERISA (Employee Retirement Income Security Act) reporting requirements. This makes 403(b) plans cheaper than 401(k) plans. Another main difference between the two plans is the non-discrimination testing required for 401(k) plans but not for 403(b) plans.
Non-discrimination testing is done annually, and employees earning incomes over the established limit may not participate in employer-sponsored retirement plans. Currently, the income limit is set at $305,000 annually.
403(b) vs 401(k): Practical Differences
Employers sponsoring 403(b) plans can legally make matching contributions, however, they most likely are unwilling to do so. The reason for this is that employers who make matching contributions to a 403(b) plan will lose ERISA exemption. And will subsequently be subject to more rigorous reporting requirements.
Having said that, 403(b) plan participants with over 15 years of service can make additional catch-up contributions that 401(k) participants cannot make. So, you will often find that employers providing 401(k) plans are more likely to make matching contributions.
As mentioned before, expense ratios for ERISA exempt 403(b) plans are much lower than 401(k) plans since they have less stringent reporting requirements.
Usually, the providers of 403(b) and 401(k) plans are different for the two types of plans. In general, 403(b) plans are administered by insurance companies, while 401(k) plans are administered by mutual funds or special purpose entities.
The type of administrator is the main reason why you are limited in what you can invest in with your 403(b) plan. Insurance companies prominently feature annuities, while mutual funds and special purpose companies will offer a variety of funds covering a selection of assets.
Annuities With 401(k) Plans
Although we just mentioned that 403(b) plans offer annuities, but you may see employers sponsoring 401(k) plans that also offer annuities. And that’s thanks to the Setting Every Community Up for Retirement (SECURE) Act of 2019.
The SECURE Act greatly reduces the hurdles employers faced when offering annuities as part of their retirement plan options. By following specific guidelines ERISA fiduciaries can avoid any liability should an insurance company fail on any payments of its annuities to the 401(k) participant.
Also, under section 109 of the SECURE Act, annuity plans held in a 401(k) are now portable. This means that should an annuity plan be discontinued the 401(k) participant may transfer the annuity to a new employer-sponsored plan or an IRA.
This feature means the 401(k) participant does not have to liquidate the investment. This was of concern, as early liquidation of investments may be subject to penalties and fees.
403(b) vs 401(k): Can I Contribute to Both?
It is possible to contribute to both a 403(b) plan and a 401(k) plan. For example, if you are employed by a for-profit organization but also have a job with a government employer. In this case, the government employer may offer a 403(b), and the for-profit employer may offer a 401(k).
In this scenario, you may contribute to both plans but up to the maximum limit set by the IRS, which for 2022 is $20,500, plus $6,500 if you are over the age of 50.
What Are the Contribution Limits: 403(b) vs 401(k)?
403(b) and 401(k) plans both have the same contribution limit. For the tax year 2022, this limit is set at $20,500. If you are in a 401(k) your employer may make matching contributions up to the same limit of $20,500.
403 (b) vs 401(k) Matching Contributions
Note that there is a further limit on combined contributions, for the tax year 2022 this limit is set at $61,000. Since a combined maximum contribution would only be equal to $41,000 this is not of concern to most employees.
However, if you are working for more than one employer and have more than one 401(k) then your maximum combined contribution limit is set at $61,000 across all plans.
Catch-Up Contributions: 403(b) vs 401(k)
As mentioned earlier people over the age of 50 can make extra contributions on top of the regular limit. For both 403(b) plans and 401(k) plans the catch-up contribution is $6,500 for 2022.
However, things change quite a bit with the 403(b) plan. Employees who have at least 15 years of service with the same eligible employer can make additional contributions annually that are the lesser of:
- $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or
- $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.
Note that if you have 15 years of service with the same eligible employer, and you are over 50 years of age, you may make catch-up contributions under both provisions: 15 years of service and age over 50.
If you only have one employer, you don’t get to choose which retirement plan you would prefer to have. It solely depends on whether your employer is a government organization or some other tax-exempt organization, or if it is a for-profit company.
Remember that, if you have more than one employer and they are of both types, say a public school, and a private company you may be eligible for both 403(b) and 401(k) plans. However, your contribution limits are the same for the combined retirement plans.
Something to bear in mind is that you cannot hold alternative assets in your 403(b) or 401(k). And that includes gold and silver. If you want to add precious metals to your retirement portfolio and take advantage of a tax-enhanced status you would need to open a gold IRA. You can check out our reviews of the top rated gold IRA companies here.