401(k) vs 403(b) – What You Need to Know
Posted by Frank Gogol in Investing | Updated on May 27, 2023
Are you close to retirement? If you are or you’re just trying to make plans in advance, you probably know you have different retirement account options to choose from. But while you have so many primary retirement account choices, it’s hard to know which one is the best for you, as plans have some significant differences to keep in mind. Therefore, in this article, you are going to learn more about 401(k) vs 403(b). So, you’ll be able to make your choice afterward.
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Difference Between a 401(k) and 403(b) Plan
Before you decide which one is better for you, you have to make sure you understand what both plans can offer you. Here is what they include and what the main differences between the two are.
What Is a 401(k) Plan?
401(k) retirement plans are usually offered by many for-profit companies. They work by letting employees save for retirement in advance. Back in 1978, the Revenue Act was passed by the Congress, which is what led to Section 401(k). Over time, a huge amount of big companies started offering retirement plan options. Thus, people can have different money amounts deducted from their salaries every month, which can then contribute to their retirement plan. In 2020, there were over $6.3 trillion invested into these plans.
Not to mention that 401(k) plans are qualified plans. This means that the company will have tax benefits when putting money on the retirement account for you. You can choose to have money from your salary sent to your plan before the funds and taxes of the IRS.
If you want to withdraw some of the money before you reach the retirement age, this may not be possible. Usually, you are not allowed to withdraw money from most plans until you are at least 59 ½. In other situations, you may have to meet some conditions imposed by the IRS in order to withdraw money before retiring.
Another thing to mention regarding 401(k) plans is the fact that they pretty much limit your investment choices. For example, back in 2016, there were only 27 choices for 401(k) plans. This is different from an IRA, where you had the option to pick between multiple traditional investing product types.
Some fees will also apply depending on your plan, so you have to be wary of this.
What Is a 403(b) Plan?
In general, nonprofit organizations are the ones offering you a 403(b) plan option. While some organizations may give both types of retirement plans to choose from, it’s very rare. Nonprofit organizations, including religious groups, hospitals, schools, and others have 403(b) accounts available. Meanwhile, a for-profit company will not allow 403(b) plan options.
In essence, this account works similarly to a 401(k). You can make deposits that are tax-deferred, and you will have to follow the same rules regarding withdrawals. You have the same contribution limits as well.
But while they share similarities, the two plans are different, and they come with different benefits. What you get with one may not be available with the other. Some things offered by a 403(b) will not be available if you have a 401(k) plan.
What’s the Difference?
The difference between the two types of plans comes is the fact that some employees will be qualified to contribute an additional $3.000 to their plan if they have a 403(b). It applies when the person is part of a qualified organization and has 15 years of experience. It is not something you can get with a 401(k) account.
There is also another significant difference to keep in mind. You have different investment choices. That being said, 401(k) may offer a variety of mutual funds for investing options. At the same time, this plan can offer other choices. Meanwhile, with a 403(b) plan, you only have access to annuities and mutual funds. So, it is more limited in terms of investment options compared to a 401(k) plan.
Legal Differences Between 401(k) and 403(b) Plans
There are also some differences between the two plans in the legal area. For instance, there are various regulations given by the Employee Retirement Income Security Act which the 403(b) plan doesn’t have to comply with. To give an example, 403(b) plans will not have to go through tests for nondiscrimination. The tests exist to make sure there are no employees with high compensations who receive an unreasonable benefit amount from their plan. It is something that is done every single year.
This is the case for 403(b) plans because there is a Department of Labor regulation that doesn’t put the employer-sponsored label on 403(b)s if the employer doesn’t fund any contributions. However, when the employer makes contributions, the guidelines imposed by ERISA will apply to the 403(b) plans as well.
Another thing to bear in mind is that investment funds have to qualify as registered investment companies under the Securities and Exchange Act of 1940 to be included in 403(b)s. This doesn’t apply when it comes to 401(k) plans.
Practical Differences Between 401(k) and 403(b) Plans
Apart from the legal differences, there are also some practical differences. First of all, 403(b) plans that are non-ERISA might have lower expense ratios considering there are less strict reporting requirements.
With 403(b) plans, even though they can legally give participant employer matches to the contributions the participants make, employers do not want to give these matches most of the time. This is so they don’t lose the ERISA exemption.
Therefore, 401(k) plans have a higher rate of match programs. Still, 403(b) plans will allow employees with experience of over 15 years to make extra contributions to the plans.
It’s also important to know that there are different administrators and providers for every plan. Insurance companies are the ones administering 403(b) plans, whereas mutual fund companies tend to administer 401(k) plans.
403(b) vs. 401(k): Which Is Better?
Both plans have their benefits, but the 403(b) may seem more attractive to you. However, despite the things that make one or the other more appealing, none of it is really better than the other. Both of them are great in their own ways.
In order to decide which one is the best for you, you will have to analyze the investment options that each plan provides. Usually, larger companies have lower plan fees thanks to the big number of people participating. Meanwhile, a smaller company might make you consider a lower-cost index fund instead. Otherwise, actively managed funds will have higher costs.
What you can do is participate in the plan up to the highest amount possible as long as your company matches the deposits you make. Once this is done, you can open an IRA if the fees are too high to handle.
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The Bottom Line
401(k) and 403(b) retirement plans are amazing in their own ways, but at the end of the day, you have to decide which one is better for you. Therefore, make sure to analyze both of them and see which one has more convenient options overall. Choose one that will be better in the long run so that you can live a happy retirement.