The Differences Between 401(k) and 403(b) Plans
Named after sections 401(k) and 403(b) of the tax code, respectively, both 401(k) plans and 403(b) plans are tax-advantaged retirement vehicles offered by employers. The primary difference between the two is the type of employer sponsoring the plans—401(k) plans are offered by private, for-profit companies, whereas 403(b) plans are only available to nonprofit organizations and government employers.
Once also known as tax-sheltered annuities, 403(b) plans used to be restricted to an annuity format. This restriction was removed in 1974.
Legal Differences Between 401(k) Plans and 403(b) Plans
403(b) plans are unable to accept profit sharing from their sponsor employer. This makes sense, because the entities that are allowed to offer 403(b) plans—nonprofits and the government—are not working to make a profit. Also, 403(b) plans do not have to comply with many of the regulations in the Employee Retirement Income Security Act (ERISA), which governs qualified, tax-deferred retirement investments, including 401(k)s and 403(b)s. For example, 403(b)s are exempt from non-discrimination testing. Done annually, this testing is designed to prevent management-level or "highly compensated" employees from receiving a disproportionate amount of benefits from a given plan.
The reason for this and other exemptions is a long-standing Department of Labor regulation, under which 403(b) plans are not technically labeled as employer-sponsored as long as the employer does not fund contributions. However, if an employer does make contributions to employee 403(b) accounts, they are subject to the same ERISA guidelines and reporting requirements as those who offer 401(k) plans.
Additionally, investment funds are required to qualify as a registered investment company under the 1940 Securities and Exchange Act in order to be included in a 403(b) plan. This is not the case for 401(k) investment options.
Practical Differences Between 401(k)s and 403(b)s
Even though 403(b) plans are legally able to provide employer matches to their participants' contributions, most employers are unwilling to offer matches so they do not lose ERISA exemption. Consequently, 401(k) plans offer match programs at a far higher rate. However, if an employee has over 15 years of service with certain nonprofits or government agencies, they may be able to make additional catch-up contributions to their 403(b) plans that those with 401(k) plans can't.
Typically, the plan providers and administrators are different for each type of plan. 401(k) plans tend to be administered by mutual fund companies, while 403(b) plans are more often administered by insurance companies. This is one reason why many 403(b) plans limit investment options and prominently feature annuities while 401(k) plans tend to offer a lot of mutual funds.
For non-ERISA 403(b) plans, expense ratios can be much lower since they are subject to less stringent reporting requirements.
Nevertheless, 401(k) plans and 403(b) plans are very similar as far as retirement vehicles go. Both have the same basic contribution limits, both offer Roth options and both require participants to reach age 59.5 prior to making distributions.
Though it is not very common, it is possible to have an employer offer both a 401(k) and a 403(b). In these cases, employees may contribute to both accounts. (For related reading, see: Can you have a 403(b) and also contribute to a 401(k)?)