What's the Difference Between a 401(k) and a 403(b)?
Human Interest - The 401(k) provider for small and medium-sized businesses

What’s the Difference Between a 401(k) and a 403(b)?

By The Human Interest Team -

Both 401(k) and 403(b) plans are tax-advantaged, employer-sponsored retirement plans. Each account plan is named for the sections of the IRS code that explain their structure: 401(k) and 403(b), respectively. The key difference between 401(k) and 403(b) plans is the organizations that can sponsor them. Private, for-profit corporations offer 401(k) plans, and non-profit organizations or government employers can offer 403(b) plans. There are also some structural differences between the two. For example, 403(b) plans used to be annuities, though this limitation ended in 1974, and each plan type continues to offer slightly different investment options.

What Is a 401(k) Plan?

For-profit companies can sponsor 401(k) plans that allow their employees to make tax-deferred contributions for retirement. Employees can make pre-tax or post-tax contributions up to a contribution cap amount established by the IRS every year. That cap is $19,000 in 2019 and will be $19,500 in 2020 for employees under the age of 50. Employees who are 50 years or older can make an additional catch-up contribution of up to $6,000 in 2019 and $6,500 in 2020.

Employers can also make contributions or add options to their employees’ 401(k) accounts, but they are not required to do so. These options include matching contributions, non-elective contributions, and profit-sharing features. Employers may make contributions to incentivize long-term employment. They also receive a tax benefit for the contributions they make to your account because the IRS considers 401(k)s to be “qualified plans.” Employers can also permit their employees to borrow from their own 401(k)s, up to the lesser of 50% of their account or $50,000, provided that the loan is repaid within five years. Nearly 50% of companies in the United States offered their employees 401(k)s by 1983, and today’s 401(k) accounts hold over $4.8 trillion.

The earnings that your contributions make grow on a tax-deferred basis. That is, you don’t pay taxes on them until you start making withdrawals in retirement. You can start making withdrawals once you reach 59 1/2 years old, and you are required to begin taking Required Minimum Distributions (RMDs) by the start of April following the year you turn 70 1/2. Failure to wait until the approved requirement age before making withdrawals can result in penalty fees. So can failing to take RMDs once you turn 70 1/2.

When you leave an employer, your 401(k) comes with you. You can roll it over into your new 401(k) with your new employer or convert it to a traditional or Roth IRA, a 457 plan, a 403(b) plan, or a SEP IRA.

The downsides of 401(k)s include their fees and their limited investment options. Depending on your plan, you may or may not have access to low-fee options or investments with a high rate of return.

What Is a 403(b) Plan?

A 403(b) plan operates very similarly to a 401(k) plan. Public schools, organizations that are exempt from paying taxes under 501(c), and qualified ministers offer these plans. Participants can invest in annuities and mutual funds.

If you have a 403(b), you can make tax-deferred contributions — which have the same cap as 401(k)s in most circumstances — and withdraw money under the same rules.

One key advantage of 403(b) plans is that the vesting periods, or the periods in which you don’t fully own employer contributions to your account, are typically shorter. Many plans also have immediate vesting.

Special MAC Rule With 403(b) Plans

The Maximum Allowable Contribution (MAC) rule allows employees with 403(b)s to make an additional contribution in select circumstances. If you work for 15 years for a “qualified organization,” you may be able to contribute an additional $3,000. While the IRS provisions allow for this, your employer may not.

403(b) vs. 401(k) Comparison: Similarities

As we’ve stated, 403(b)s and 401(k)s share a lot of similarities. At a glance, those similarities include:

403(b) vs. 401(k) Comparison: Differences

There are some key differences between these plans that you need to know about. Aside from the differences between types of organizations that can offer the different plans, there are specific limitations both accounts face. These differences include:

What Are the Benefits of 403(b) vs 401(k)?

Both 403(b)s and 401(k)s offer unique benefits. However, the investment options available within the plan are much more important than the type of plan itself. Generally speaking, larger companies offer plans with lower fees and more investment options. It’s important to look for investment options that have total fees below 1%. Higher fees are a cause for concern. Another important element is the employer match: Regardless of the type of plan, investing enough to max out your employer’s matching contributions ensures you don’t leave free money on the table. Either plan, if you invest strategically, can help you prepare for your future.

If you want to learn more about 401(k)s and 403(b)s, or your company needs help managing their plans, Human Interest is here to help. Contact us today.

The Human Interest Team The Human Interest Team

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

Small and medium businesses can be prepared, too.

Start a great retirement benefit for less than the cost of one employee’s health insurance.

Human Interest - The 401(k) provider for small and medium-sized businesses

Get free 401(k) resources now. Learn more about 401(k)s for you and your company.

Get free 401(k) resources now. Learn more about 401(k)s for you and your company.