What’s the Difference Between a 401(k) and a 403(b)?
If you’re the business owner and the only employee, you can set up a one-participant 401(k) for yourself and your spouse. A 403(b) can only be offered by public schools, colleges, universities, churches, or 501(c)(3) charities. To be eligible for this type of plan, you’ll need to work for one of these types of employers.
Investment Choices
Another difference between a 403(b) and a 401(k) is the investment choices. Most 401(k) plans offer different types of mutual funds as their investment choices, but they can include other investment types. 403(b) plans can only offer mutual funds and annuities. Technically, 403(b)s are more limited on investing options than 401(k)s, but if there is a choice between mutual funds, then a 403(b) can be nearly as flexible as a 401(k). 401(k)s and other company-sponsored retirement plans might also limit your investment choices. Fees also eat into your balance, and depending on the plan’s quality; you may be stuck with less-than-ideal options from a fee and investment perspective.
Contribution Limits
Both 401(k) and 403(b) plans allow employees to contribute up to $20,500 in 2022 ($22,500 in 2023). In addition, if you’re age 50 or older, you can make a “catch-up” contribution annually of $6,500 in 2022 ($7,500 in 2023). For 403(b) plans, one difference applies to a small subset of employees—if your qualified 403(b) plan permits and you have 15 years of service. You may be eligible to contribute more to your 403(b) on top of the annual contribution limit. This option is not available with a 401(k).
Tax Benefits
401(k) and 403(b) plans offer pre-tax contributions, meaning your contribution amounts reduce your taxable income before income taxes are deducted from your paycheck. For example, if you earned $60,000 and made $10,000 in contributions, you would only be taxed on $50,000 in income. However, Roth 401(k) plans are similar but offer different tax advantages than 401(k) and 403(b) plans. You don’t receive any upfront tax benefit with a Roth 401(k). However, your distributions in retirement are tax-free.
Distributions
You can’t withdraw money out of most 401(k) and 403(b) plans until you reach age 59½. If you make an early withdrawal, you must pay income taxes on the amount and a 10% penalty. To avoid the penalty, you must meet specific conditions per the Internal Revenue Service (IRS). Also, you must begin taking distributions based on a minimum withdrawal amount by age 72—called required minimum distributions (RMDs). All employer-sponsored retirement plans must follow the RMD rules, including 401(k) and 403(b) plans.
Other Considerations
There are other benefits to nonprofits that might make a 403(b) more attractive, but the type of plan doesn’t matter to the vast majority of employees. If you have the choice, one isn’t necessarily better than the other. It’s important to consider the investment options and fees with the plan. Typically, the larger the company, the lower the plan fees because more people participate, which brings costs down. Also, consider that index funds usually have lower fees than higher priced actively managed funds.
The Bottom Line
401(k) and 403(b) plans are great retirement plans. If your employer matches your contributions, be sure to contribute enough to qualify for the employer match. Since the key difference is the types of investments within each type of plan, it helps to become familiar with the various investments so you can choose the ones that fit your goals. A 401(k) might provide more flexibility when choosing your investments, while a 403(b) can only offer mutual funds and annuities. However, there might be many mutual funds offered, and annuities can provide additional, steady income. Please consult a financial planner and tax professional before considering investments and annuities. The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a financial professional to determine a suitable retirement savings, tax, and investment strategy. For example, if your employer offers a 9% match, and you contribute 9% of your salary, they will equal that amount. If you contribute 4%, they will contribute 4%; if you contribute 10%, they will contribute 9%. You usually have to work at the company for a set amount of time to become “vested” and keep the employer contributions if you leave your job.
