401(a) vs. 403(b) retirement plans: What is the difference?

LAST REVIEWED Nov 24 2020 9 MIN READ

By The Human Interest Team

Key Takeaways

  • While similar, the main difference between 401(a) and 403(b) plans is often eligibility and plan design.

  • 401(a) plans allow employers to require enrollment for eligible workers and set contribution models—but employers must also contribute to these plans.

  • 403(b) plans, on the other hand, make enrollment voluntary.

If you’re thinking of enrolling in a retirement plan, you’ll likely find yourself making a 401(a) vs. 403(b) comparison. Both of these retirement plans have their pros and cons, which you have to properly weigh in order to determine which one better suits your needs and goals.

Below is our guide to understanding the difference between 401(a) and 403(b).

What is a 401(a) plan?

A 401(a) plan refers to an employer-sponsored retirement plan that works in a similar way to a 401(k) plan. 401(k) sponsors are usually private companies, while 401(a) sponsors are typically government agencies, non-profit organizations, and educational institutions. In most cases, sponsors of 401(a) plans enjoy greater control in terms of plan structure. For example, employers set the eligibility requirements. However, they usually make it mandatory for qualified employees to participate. By doing so, they’re helping their employees to save money for their retirement and providing tax incentives.

According to IRS rules, employers are required to contribute to their employees’ 401(a) plans. As such, signing up for such a plan essentially entitles you to “free money.” All sponsors must comply with this rule even if they decide to make it optional for employees to make contributions.

Also, employers are allowed to defer a certain percentage of their employees’ salaries or paychecks into their 401(a) plans. They can set a fixed percentage for the entire life for the plan or permit employees to change the rate at a specific time of the year. Due to the structure of a 401(a) plan, some employees may have the option to make contributions to their 401(a) accounts or traditional pensions, especially if they’re government employees.

Tax advantages of a 401(a) plan

To better understand what is 401(a) vs. 403(b), it’s important to look at how they differ in terms of tax advantages. When you participate in a 401(a) plan, you’ll be contributing pretax dollars, which means that your employer will deduct your contribution from your salary before the government takes a cut. Different employers may offer different investment options, but you’ll typically be able to invest in stocks, mutual funds, and bonds that reputable investment firms manage.

Although your money remains in your 401(a) account, it grows without incurring taxes. Unlike a standard brokerage account, this type of account won’t subject your interest, capital gains, and dividends to tax each year. You’ll only have to pay regular income tax when you’re able to make qualified withdrawals, which is typically at the age of 59 1/2. If you withdraw funds earlier, you’ll incur a 10% penalty plus income tax on the withdrawal amount.

401(a) contribution limits

The contribution limit for 401(a) plans is $57,000 in 2020. This limit applies to the combined total of employee and employer contributions. However, if your income is below the contribution limit, you and your employer can only contribute up to your total salary. For example, if you earn $45,000 a year, you and your employer are only allowed to contribute that amount to your 401(a) account for the year. The contribution limit for a 401(a) account is usually higher than that of other types of retirement plans.

What is a 403(b) plan?

If you’re contemplating 401(a) or 403(b), which is better for you? It depends on the type of organization that employs you. A 403(b) plan refers to a tax-favored retirement plan that’s intended for employees of 501(c)(3) organizations and public schools. Some examples of organizations that typically offer 403(b) plans include:

  • Public schools.

  • 501(c)(3) tax-exempt organizations.

  • Cooperative hospital organizations.

  • Religious institutions.

As in 401(a) plans, sponsors of 403(b) plans have the authority to set eligibility requirements. However, the IRS usually requires them to set up one of the following types of accounts:

  • Custodial accounts that invest in mutual funds.

  • Annuity contracts with insurance companies.

  • Retirement income accounts for religious organization employees that invest in annuities or mutual funds.

When trying to understand the difference between a 401(a) plan vs. a 403(b) plan, it’s important to know that a 403(b) plan typically offers annuity options from insurance providers, while a 401(a) plan usually facilitates mutual fund investments. It’s worth noting that most colleges and universities offer attractive employer contributions.

In order to make an informed decision when choosing between a 401(a) plan and a 403(b) plan, you have to take your financial goals and risk tolerance into consideration. You may find one more suitable than the other, but no two retirement plans are created equal. If your employer has both a 401(a) plan and a 403(b) plan, you may want to select the plan that offers the types of investments that are right for you.

Tax advantages of a 403(b) plan

When it comes to tax treatment, a 403(b) plan functions in the same way as a 401(a) plan. As a 403(b) participant, you’ll make contributions on a pretax basis, and your money will also grow without being subject to tax. Additionally, you’ll have to pay regular tax on eligible withdrawals, which you can make at the age of 59 1/2. If you choose to make an early withdrawal, you’ll also be required to pay a 10% tax penalty.

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403(b) Contribution limits

According to IRS rules, employees who enroll in a 403(b) plan are allowed to contribute a maximum amount of $19,500 in “elective deferrals” to their accounts in 2020. However, if you’re 50 or older and you maxed out your deferrals, you’re allowed to make an additional catch-up contribution of $6,500. (Elective deferrals are the money that’s deducted from your paycheck and put into your account.)

If your employer is contributing to your 403(b) account, they can contribute a maximum additional amount of $37,500 in 2020, which brings the total contribution limit to $57,000. 

If your annual income is less than the contribution limit of $57,000, your maximum contribution is equal to your total compensation in the year. For instance, if you earn $45,000 in 2020, the total contribution you and your employer make to your 403(b) account can’t exceed that amount.

If you want to know more about the difference between 401(k), 401(a), and 403(b) accounts, don’t hesitate to get in touch with the experts at Human Interest.

Want to learn more? Read one of our guides:

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.

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