403(b) Vs. 401(k) Plan: An Overview
The 403(b) plan and the 401(k) plan are both tax-advantaged retirement savings plans sponsored by employers for their employees. The biggest difference in the 403(b) vs. 401(k) is that the 403(b) is strictly for government and non-profit employees while the 401(k) is for employees of companies in the private sector.
Another significant difference in 403(b) vs. 401(k) has been removed. Employees with 403(b) plans originally were restricted to investing in tax-sheltered annuities while those with 401(k) plans had a wider choice of investments. That restriction on the 403(b) was loosened in 1974, allowing participants to choose mutual funds.
The 403(b) and the 401(k) both get their names from the sections of the Tax Code that defined them.
Key Takeaways
- 401(k) and 403(b) plans are tax-advantaged retirement plans. That is, they include tax breaks for both the employee and the employer.
- 401(k) plans can be offered by for-profit companies to their employees.
- 403(b) plans are offered to employees of non-profit organizations and government entities.
- Participants in either type of plan contribute pre-tax or post-tax money through regular payroll deductions. The employer may also choose to contribute.
401(k) Plans
A 401(k) plan allows employees to pay into a retirement savings account through automatic payroll deductions, up to an annual maximum dollar amount. The employer selects the investments that the employee may choose from. These are usually a choice of mutual funds, ranging from the very conservative to the more aggressive.
The employee who chooses a traditional 401(k) plan gets an immediate tax break with every contribution, up to the maximum. The money invested in the fund will not be taxed until it is withdrawn, presumably after retirement. This is called a "pre-tax" plan.
Some employers also offer a Roth 401(k) plan. In this case, the income tax is paid immediately but no taxes will be owed when it is eventually withdrawn properly. The Roth is a "post-tax" plan.
The employer offering a 401(k) plan may make matching contributions on behalf of employees, up to a limit, and may also add a profit-sharing feature to the plan.
These plans are often vested. That is, the employee must stay with the company for a set time, usually a few years, to have the full right of ownership over the money in the fund.
403(b) Plans
The features of a 403(b) plan are comparable to those found in a 401(k) plan. The big difference is in the participants. They are employees of public schools, tax-exempt organizations, and certain ministers.
Participants include teachers, school administrators, professors, government employees, nurses, doctors, and librarians.
Many plans vest funds over a shorter period than 401(k) plans or may allow immediatevestingof funds. Note that there are income restrictions on 403(b) plans not found in 401(k)s.
The employee can invest in annuities or mutual funds.
People with salaries above a certain level cannot contribute to a 403(b) but the limit is high: It's $330,000 for the 2023 tax year, rising to $345,000 in 2024.
To participate in a 403(b) plan, your income cannot be more than the annual limit set by the IRS, which is $345,000 for the 2024 tax year.
Legal Differences Between 401(k) and 403(b) Plans
Unlike a 401(k) plan, 403(b) plans may not have to comply with all of the regulations in the Employee Retirement Income Security Act (ERISA). Notably, governmental employers, non-electing churches, and certain other organizations are exempt from following ERISA requirements.
For example, 403(b)s are typically exempt fromnondiscrimination testing. Done annually, this testingis 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 ERISAguidelines 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 to be included in a 403(b) plan. This is not the case for 401(k) investment options.
Practical Differences Between 401(k) and 403(b) Plans
Even though 403(b) plans are legally able to provide employer matches to their participants' contributions, most employers are unwilling to offer matches and give up their ERISA exemption.
Consequently, 401(k) plans offer match programs at a far higher rate than 403(b) plans. However, if an employee has more than 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.
Another difference between 401(k) and 403(b) plans is that expense ratios can be much lower for 403(b) plans that are exempt from the stringent ERISA reporting requirements.
Typically, the plan providers and administrators are different for each type of plan. Notably, 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 tend to limit investment options and prominently feature annuities, while 401(k) plans tend to offer a variety of mutual funds.
The SECURE Act and Annuities in 401(k) Plans
Employees with 401(k) plans may see more annuity options in their plans since the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. This law eliminates many of the barriers that had discouraged employers from offering annuities as 401(k) options.
By implementing certain guidelines and procedures, ERISA fiduciaries are now protected from being held liable should an annuity carrier have financial problems that prevent it from meeting its obligations to its 401(k) participants.
Additionally, under Section 109 of the SECURE Act, annuity plans offered in a 401(k) are now portable. This means that if the annuity plan is discontinued as an investment option, participants can transfer their annuity to another employer-sponsored retirement plan or IRA, thereby eliminating the need to liquidate the annuity and pay surrender charges and other fees.
What Are the Contribution Limits for 401(k) and 403(b) Plans?
The plans have the same yearly contribution limits set by the IRS at $22,500 for the 2023 tax year and $23,000 for 2024. People over age 50 can contribute an additional $7,500 in both years.
Can I Contribute to Both a 401(k) and 403(b) Plan?
If you have two jobs, you might be offered both, assuming that one employer is a private company and the other is a government agency or a non-profit. In that case, you are allowed to contribute to both.
You will still be subject to the overall limit on your combined contributions.
How Do Catch-Up Contributions Work With a 401(k) vs. 403(b) Plan?
With a 401(k) or 403(b), plan participants age 50 and older can make additional catch-up contributions above the standard contribution maximum. The catch-up contribution limit is $7,500 for both the 2023 and 2024 tax years.
In a 403(b) plan, employees with at least 15 years of service with the same employer can also make additional annual contributions that are the lesser of:
- $3,000,
- $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.
401(k) vs. 403(b): Which Is Better?
Both types of defined-contribution retirement accounts are solid retirement accounts that offer tax advantages and investment options for retirement. The major difference is in what type of employer is offering the plan,
The Bottom Line
These two retirement plans, the 401(k) and the 403(b), are very similar in their benefits and their restrictions.
Both have the same basic contribution limits, both offer Roth options and both require participants to reach age 59.5 before taking distributions.
Correction—July 9, 2022: This article has been edited to highlight the ERISA exemptions for some 403(b) plans.
