Key Takeaways
Eligibility Distinctions: A 403(b) is exclusive to public schools and select tax-exempt organizations, including 501(c)(3) entities, while a 401(k) can be offered by nearly any type of company, including for-profits and nonprofits.
Commonalities: Both 401(k) and 403(b) plans have a maximum annual contribution limit of $22,500 for 2023, with an additional catch-up contribution of $7,500 for employees over age 50. Both also allow for Roth deferral options.
Variability in Offering: While 401(k)s are commonly provided by larger for-profit entities, many nonprofit organizations might choose to offer both 401(k) and 403(b) plans to their employees.
Employers considering offering a retirement plan for their employees have multiple choices. Specifically, tax-exempt nonprofit organizations can choose between offering a 403(b), a 401(k), or both.
So, what exactly are the main differences between a 403(b) and a 401k retirement savings plan? This article breaks down the differences, pros and cons, and gives employers some guidance to help make an informed decision.
Please contact us if you have any questions about launching your own retirement accounts. We have experts available to help you every step of the way.
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403(b) vs. 401(k) plans: Which organizations are eligible for 403(b) plans?
When comparing 403(b) and 401(k) retirement plans, it is essential to understand their key differences.
403(b) eligibility
A 403(b) plan, also known as a tax-sheltered annuity (TSA), is available exclusively to public schools and select tax-exempt organizations.
Eligible organizations for a 403(b) include:
501(c)(3) entities under the Internal Revenue Code
Public school systems
Cooperative hospital service organizations
Uniformed Services University of the Health Sciences (USUHS)
Public school systems governed by Native American tribal governments
Certain ministries
Non-profit institutions such as universities, religious organizations, or social service agencies
These organizations may serve various purposes, such as religion, education, charity, science, literacy, or preventing cruelty to children or animals. Typically, they are structured as corporations, community chests, funds, or foundations. Note that individuals, partnerships, and for-profit corporations generally do not qualify for 403(b) plans.
401(k) eligibility
In general, almost any type of company may offer a 401(k) plan, making it more widely available throughout the United States. Though 401(k)s are primarily offered by larger for-profit companies, many nonprofit entities also offer 401(k) plans to their employees. In fact, many nonprofit organizations may choose to offer both a 401(k) and a 403(b).
Now that the eligibility requirements and the types of employers that qualify for 403(b) and 401(k) retirement savings accounts are clear, you'll have to decide which option is the best for you and your employees. Before deciding, it's important to consider additional information to help you navigate the selection process. While there are similarities between the plans, they are not identical.
H2: 401(k) and 403(b): Similarities and their impact on income tax
Here's what they have in common:
The additional catch-up contribution for employees over age 50 is $7,500, for a total allowable contribution of $30,000.
All company employees may be eligible to participate.
The total employee elective deferral plus employer contribution limit is limited to the lesser of $66,000 or 100% of the employee’s contributions.
Both 401(k) and 403(b) plans may be terminated according to pre-determined plan-governing rules.
Both types of retirement plans allow for Roth deferral option where employees contribute after-tax money.
More information on the Roth vs. traditional distinction:
401(k) vs 403(b): Breakdown of differences and their tax advantages
| 401(k) plan | 403(b) plan | |
|---|---|---|
| Investment options | Any investment option is allowed according to the Employee Retirement Income Security Act of 1974 (ERISA), including mutual funds, annuity contracts, and individually managed portfolios. | Annuity contracts or custodial accounts invested in mutual funds. (Churches may have additional options.) |
| 15-years of service catch-up | Not available | Allowed if plan document permits. If over age 50, must be applied before the $7,500 over-age 50 catch-up contribution is applied. |
| Plan hardship withdrawals | Allowed if plan document permits | Allowed if plan document permits |
| Applicability of ERISA | In general, subject to ERISA. | Depends upon the circumstances and construction of the plan. |
| IRS testing | Subject to annual IRS nondiscrimination testing, including the ADP test and ACP test and top-heavy determination | Subject to annual IRS nondiscrimination testing, but only the ACP test. |
How does the employer match work in 403(b) and 401(k) plans?
In both 403(b) and 401(k) plans, the employer match is a valuable benefit for workers. Matching contributions incentivize workers to save for retirement and reduce their taxable income. The employer or business owner agrees to contribute money to the employees' employer-sponsored retirement plan based on the employees' contribution and salary. That contribution could be a full match, where 100% of the employees' contributions are matched dollar-for-dollar, or a partial match, such as 50%, where the employer will contribute 50 cents for every dollar the employees contribute.
Employers also choose how much of an employee's contribution to match for both plans based on the percentage of the employee's salary contributed. For example, an employer may match dollar-for-dollar until the employee contributes 3% of their salary and will not match any contributions an employee makes over 5%.
Employer matches for 401(k)s and 403(b)s often include "vesting" clauses, which require employees to stay in their jobs for a certain number of years to keep the full match. Employees might be entitled to 100% of an employer match after three years, for example, but none if they leave before then.
Employers may want to work with a certified financial planner to determine the appropriate match for each plan.
Nonprofit retirement plan cost considerations
The 403(b) was introduced in 1958 as a tax-sheltered annuity arrangement, and participants could only invest in annuity products. Generally, annuity contracts charge maintenance and operational fees that can cost more than comparable mutual fund expenses. Over the ensuing decades, 403(b)s became synonymous with annuity fees. However, the 403(b) is evolving, and distancing itself from annuities.
Annuities in 403(b) plans
Many modern 403(b) are now able to be invested in the same way as 401(k) plans. However, according to 2019 data from Plan Sponsor Council of America, more than half of 403(b) plan sponsors (53.5%) offer annuities as a retirement distribution option, (compared to 17.2% of 401(k) plan sponsors). Ultimately, the plan sponsor and/or fiduciary has the final decision to make investment decisions.
How to decide: 401(k) vs. 403(b)
401(k) pros: The main benefit of a 401(k) over a 403(b) is flexibility. Would your organization potentially change from a 501(c)(3) to a C-Corp or S-Corp? If so, a 401(k) would stay with you during that transition, whereas a 403(b) would not.
403(b) pros: 403(b)s have easier compliance testing requirements as they are exempt from several annual IRS nondiscrimination tests. Plus, there are special considerations for edge employees and government employees, including nurses, doctors, and librarians when choosing between a 401(k) and a 403(b) plan.
Human Interest's retirement savings plan solutions
At Human Interest, we pride ourselves on offering a 403(b) plan that is on par with our 401(k) offerings, in the best interest of organizations and employees who do a lot of good for the world. We offer solutions that consider the retirement goals of our plan participants, and we ensure that our fees are transparent.
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Article By
Trenton ReedTrenton Reed is the Manager of Content Strategy at Human Interest. He has nearly a decade of experience writing for Fortune 500 and SMB companies across finance, technology, and other verticals.