In general, 401(k) plans and 403(b) plans are very similar—both are defined-contribution retirement plans offered by employers to employees. The primary difference between the two is the type of employer who sponsors them. The 403(b) plan is offered to employees at non-profit tax-exempt companies, such as charitable organizations and public schools and universities, while 401(k) plans are offered by private, for-profit companies.
- Non-profit organizations offer their employees 403(b) plans; for-profit companies offer 401(k) plans.
- Their similarities include tax benefits, contribution limits, and when you may withdraw money without a penalty.
- A major difference is that 401(k)s typically offer a lineup of mutual funds in which to invest, while 403(b)s commonly offer annuities.
It is uncommon for an employer to offer both a 401(k) and a 403(b), but if your employer does offer both, you may choose to participate in either or both (if allowed). If you are among those with a choice, you'll need to understand the particulars of how each plan works and their key differences, such as investment options, to decide what works best for you.
401(k) and 403(b) Plans: The Similarities
Both are tax-advantaged retirement plans. Earnings and returns grow tax-free until you withdraw them in retirement. The contribution limits are the same for each. In 2020, the maximum tax-deferred contribution allowed is $19,500, up from $19,000 in 2019.
Those 50 and older may contribute an additional $6,500 (up from $6,000 in 2019), which is known as a catch-up contribution. The contribution limit is the same whether you contribute to one or to both a 403(b) and 401(k). Employers also may choose to make matching contributions, although this is less common in 403(b)s than in 401(k)s.
Employees must meet certain requirements to be able to withdraw assets. In general, plan participants in a 401(k) or 403(b) can make withdrawals with no penalty when they reach age 59½.
Both plans can offer loans to employees, but it's up to the employer whether or not they choose to make loans available.
401(k) and 403(b) Plans: The Differences
A key difference between 401(k) and 403(b) plans lies in the available investment options, though this is starting to change. Typically, 401(k) plans offer mutual funds, which range from conservative to aggressive; 403(b) plans typically offer annuities.
It may come as no surprise that mutual fund companies typically have administered 401(k) plans, and insurance companies have traditionally administered 403(b) plans. In fact, 403(b)s used to be restricted to annuities only, also known as taxed-sheltered annuities, but this restriction was lifted in 1974. Although now most 403(b) plans offer mutual funds, too, they are usually inside of a variable annuity contract. Critics of annuities often point to their complexity and high fees as negative factors.
Another difference is that some 403(b) plans allow additional catch-up contributions to employees with more than 15 years of service, something 401(k) plans cannot do. In that scenario, if your plan allows it, you can contribute an additional $3,000 a year up to a lifetime limit of $15,000. And unlike other retirement-plan catch-up provisions, you don’t need to be 50 or older to take advantage of this benefit.
What If You Are Offered Both Plan Types?
If you are a teacher—or any type of employee, for that matter—with access to both a 401(k) and 403(b), you'll need to weigh the pros and cons of each. Consider the investment options available, whether your employer makes matching contributions, and if you can make additional catch-up contributions to a 401(3)b that aren't available in a 401(k). Depending on the particulars of the plans available to you, it may make sense to choose one over the other or to contribute to both.
If your employer does not sponsor a retirement plan at this time, consider contributing to a traditional IRA or a Roth IRA. These plans allow you to contribute as much as $6,000 per year ($7,000 if you are at least age 50 by the end of the year for which the contribution is being made). In the meantime, you might want to consult with your employer about offering a retirement plan for employees.
Dan Stewart, CFA®
Revere Asset Management, Dallas, TX
A 401(k) is a private business retirement plan, usually accompanied by a tax-deductible company match. A 403(b) is a government or non-profit plan normally without a match. There is no incentive, other than altruism, to offer the match because non-profits and governments don’t need a tax deduction.
As a teacher, you most likely have a 403(b). Investing in the 403(b) can be disadvantageous as you probably could get the same or similar investment strategy directly with a mutual fund without putting it inside of a costly annuity first. In other words, there’s no point in buying an S&P 500 Index fund within an annuity with fees when you can simply invest in an S&P 500 Index fund. One exception to this would be guaranteed, fixed interest accounts with higher net-of-fee rates.