403(b) vs 401(k) – Major Difference In 2024

Securing your financial future is a crucial step. Two standard retirement savings plans are 403(b) and 401(k). Understanding the differences between these can help you make smart choices about your financial future.

403(b) and 401(k) are defined as contribution retirement plans designed to help employees save for retirement. They have evolved over the years to become essential tools for retirement savings.

Major Differences In 403(b) & 401(k)

Eligibility Criteria 

A 403(b) plan is a retirement savings account employers offer, typically in the public or nonprofit sectors. It is available to:

• public school employees
• specific non-profit organizations
• Churches and other religious organizations

The 401(k) plan is also an employer-sponsored retirement plan. It is practically offered to employees in for-profit companies and the private sector.

Eligibility criteria can vary by employer, but generally, any employee can participate in a 401(k) plan offered by their employer.

Differences In Taxes

Both 401(k) and 403(b) plans offer significant tax advantages over Roth 4019k) and Roth 403(b), respectively.

Pre-tax contributions: 403(b) and 401(k) plans offer tax advantages. With pre-tax contributions, you can boost your take-home pay now by reducing your taxable income. It’s like getting a bigger paycheck!

Roth contributions: On the other hand, Roth contributions let you pay taxes upfront, but your money can grow and be withdrawn tax-free in retirement. Think of it as paying now for a tax-free future. 401(k) and 403(b) plan offer the Roth contribution option.

Tax Deferred growth

One of the biggest perks of 401(k) and 403(b) plans is they offer significant tax benefits for employees using tax-deferred growth. This means that the money you contribute to these plans grows without being taxed until you withdraw it in retirement. And, because your contributions are typically made before taxes are taken out of your paycheck, you’ll also save on your current tax bill, reducing your tax slab.

Lower Your Current Tax Slabs (Tax Brackets)

401(k) and 403(b) plans offer a powerful way to increase your retirement savings while lowering your current tax bill. Contributions to these accounts are typically deducted from your paycheck before taxes are taken out. This reduces your taxable income. Eventually, bumping you into a lower tax bracket.

Tax Liability is Delayed

As in both pre-tax 401(k) and 403(b) plans, you’re not paying taxes on the amount contributed to the plan. But, you will eventually pay income tax on the withdrawals during retirement.

A significant advantage of tax-deferred investment accounts is the potential for compounded growth over time. If you contribute $10,000 to your 401(k) plan, your taxable income is reduced by $10,000. Your tax bracket will be leveled down. This way, you can save money on your overall tax bill.

Annual Contributions & Limits

The amount you can contribute to your 401(k) or 403(b) plan has annual limits. These limits are set by the IRS and adjusted yearly to account for inflation.

Contribution Limit

For 2024, the maximum amount you can contribute per year to a 401(k) or 403(b) is $23,000. Earlier, it was $22,500 annually.

Catch Up Contributions

Some 403(b) plans offer additional contributions to employees having 15-plus years of continued work span in qualified organizations. This type of contribution varies between employers. This type of catch-up contribution is called 15-year rule and is restricted to a contribution of $3000 each year for up to 5 years.

Moreover, In both 401(k) or 403(b) plans, employees of age 50 or older can make additional catch up contributions. For 2024, the catch-up contribution is $7,500.   

This means people aged 50 or older can contribute up to $30,500 per year to their 401(k) or 403(b) plan.  

Employer Match Contributions in 403(b) and 401(k)

An employer match is a contribution your employer makes to your 401(k) or 403(b) retirement account. It is typically based on the amount you contribute. Simply put, “Employer Contribution” or “Employer Match” is free money to boost your retirement savings significantly.

Your employer specifies a percentage of your salary they will match. For example, a common match is 50% of your contributions up to 6% of your salary.   

While there’s no inherent difference in the ability of employers to contribute to either a 403(b) or a 401(k) plan, there is a practical difference in how often they do.

401(k) plans: Employer matching contributions are more common in 401(k) plans offered by for profit companies.   

403(b) plans: While possible, employer matching contributions are less frequent. As 403(b) plans are usually offered by non-profit organizations.   

It’s important to note that this is a general trend in some organizations only and not an absolute rule. While many non-profit organizations typically do not offer matching contributions, some do. Similarly, many for-profit companies may choose not to offer such benefits. Others offer it after a certain period of time or on specific employee positions only.

Investment Options of 401(k) vs 403(b) Plans

The investment choices in a 403(b) plan are typically more limited than those in a 401(k)  plan. According to Federal Law, standard options include annuities and mutual funds. Some 403(b) plans also offer fixed or variable annuities, which can provide a guaranteed income stream in retirement.

A 401(k) plan generally gives you more investment options, like stocks, bonds, mutual funds, ETF (Exchange Traded Funds), and sometimes even IRAs. This may let you personalize your investments to match your risk and retirement goals.

Fees and Expenses – 403(b) vs 401(k)

Both plans come with administrative and investment fees. However, 403(b) plans often have higher fees due to the inclusion of annuity products. These fees can significantly impact long-term returns, making it crucial to understand and compare fee structures when choosing between a 403(b) plan vs a 401k

Withdrawal Rules and Penalties

Withdrawals are typically allowed, without penalty, after age 59½). There are specific scenarios where withdrawing early is possible. Penalties may be imposed based on reason.

Early Withdrawal

Both 403(b)  and 401(k)  plans impose penalties for early withdrawals (before age 59½).

Unless you qualify for an exception, such as:

• Death: If the account holder passes away, beneficiaries can withdraw funds without penalty.
• Disability: If you become permanently disabled, you can withdraw funds without penalty.
• Medical Emergencies: Withdrawals used to pay for uncompensated medical expenses that exceed 7.5% of your adjusted gross income (AGI) are exempt from the 10% penalty.
• Separation from Service After Age 55: You can withdraw without penalty if you leave your job (voluntarily or involuntarily) in or after the year you turn 55 (50 for government employees).
• Birth or Adoption of a Child: You can withdraw up to $5,000 per parent without penalty within one year of the birth or adoption of your child.
• First-time home purchases: There are specific exceptions to the penalty for first-time homebuyers offered by both plans.
• Higher Education Expenses (403(b) only): Some 403(b) plans allow penalty-free withdrawals for qualified higher education expenses.

These exceptions only allow you to avoid the 10% early withdrawal penalty. But still, taxes on 403(b) withdrawals apply as per your income tax bracket. It is better to withdraw the amount in intervals to avoid getting into a higher income tax bracket and losing a large sum of your funds in income tax.

Required Minimum Distributions (RMDs)

Both 401(k) and 403(b) plans are subject to Required Minimum Distributions (RMDs). This means that once you reach age 72, you must withdraw a minimum amount from your account each year. The reason is the IRS wants to tax your funds which have accumulated pre-tax savings and profits.

Failure to take RMDs (withdrawing funds) can result in a substantial penalty of 25% excise tax. The rules for calculating and distributing RMDs are similar for both plans.

Borrowing and Loans From 401(k) and 403(b)

401(k) and 403(b) plans generally allow participants to borrow from their accounts. However, the specific terms and conditions can vary depending on the plan.

Maximum Loan Amount 

Typically, you can borrow up to 50% of your vested account balance or a maximum of $50,000, whichever is less.   

Repayment Period

Loans usually need to be repaid within five years. But if you are buying a home for the first time using a loan from any of your 401(k) and 403(b) plans, the repayment period can be extended to 15 years.   

Interest Rates on 401(k) and 403(b) Loans

Your plan provider typically determines the interest rate on a 401(k) or 403(b) loan. It’s often a prime rate (benchmark interest rate set by banks) plus a certain percentage.

So, the interest rate on your loan might fluctuate based on changes in the prime rate.

Plan Rollover – 401(k) vs 403(b)

Can you roll a 403b into a 401k? 403(b) and 401(k) plans generally allow rollovers. This means you can transfer funds from one of these plans to another qualified retirement plan, such as Another 401(k) or 403(b) plan, an IRA (Traditional or Roth). If you are leaving a for-profit company and going to work in a nonprofit, plan your finances and learn how to roll over funds from 401(k) to 403(b).

Conditions Allowing Rollovers

• If your employer decides to terminate the 401(k) or 403(b) plan, you’ll typically have the option to roll over your account balance to another qualified plan.
• If your employer’s plan merges with another company’s, you might roll over your funds.
• When an account holder passes away, the beneficiary can directly roll over the deceased spouse’s 401(k) or 403(b) into or as their retirement account. 
• Change of job and employer, previous plan funds can be rolled over to another one.

Rollovers are typically tax-deferred, meaning you won’t owe taxes on the transferred amount until you withdraw the funds.   

60 Days Rollover Rule

You may owe taxes and penalties if you take a distribution from one plan and don’t roll it into a new qualified plan within 60 days. 

Direct rollover: Your funds will be transferred directly from the old plan to the new plan. This is often the preferred method to avoid potential tax implications.
Indirect rollover: You receive the funds from your old plan. Next, you must deposit them into the new plan within 60 days.

Conclusion

In summary, 403(b) and 401(k) plans offer valuable opportunities for retirement savings, but they cater to different types of employees and come with distinct features. Understanding the nuances of each plan can help you make informed decisions and optimize your retirement savings strategy. Always consider your personal circumstances and consult with a financial advisor to determine the best plan for your needs.

Common Questions