401(k) vs. 403(b): How to Pick a Retirement Plan

401(k)'s and 403(b)'s are the most widely used employer-sponsored retirement plans in the U.S.

Each plan allows participants to steer money from their paychecks to invest for retirement, earning tax-deferred interest along the way. With both 401(k)'s and 403(b)'s, taxes are taken out of withdrawals after reaching retirement, and not contributions made while on the job.

Both 401(k) and 403(b) plans are highly useful for Americans trying to sock away some cash for retirement, yet both have important differences and distinctions that set them apart from one another, and that offer ample retirement savings benefits to qualified users.

Here's a snapshot of each plan:

401(k) Plan

A 401(k) plan, named after the IRS tax code section that details 401(k)'s, is an employer-sponsored retirement plan that enables career professionals to save money for their post-working years in a tax-deferred manner. Once a worker retires, any withdrawals from a 401(k) plan are taxed by the IRS. Any contributions to a 401(k) plan can be deducted from the plan participant's taxable income; assets accumulate in a tax-deferred manner. The idea behind 401(k) plans is to defer taxes until retirement, at which point, the plan participant is in a lower tax bracket. 401(k) plans are by far the most widely used employer-based retirement plan.

403(b) Plan

A 403(b) plan is a retirement plan specifically geared toward government workers, religious organizations, hospital employees, public school and non-profit employees. Much like a 401(k) plan, it offers tax-advantaged benefits in a defined contribution savings model, which counts investment assets going into the plan (the "contribution"), leading to an unspecified amount of money in the plan once the employee retires. That differs from company pension plans, which are built on a defined benefit model, which provides a guaranteed payout (the "benefit") upon retirement, based upon years of service and cash invested in the 403(b) plan.

Key Similarities Between 401(k) Plan and 403(b) Plans

401(k) and 403(b) plans do have similar qualities and benefits, as follows:

  • Both plans have the same tax-deferred tax treatment.
  • Both plans have the same contribution limits for 2018 - $18,5000 annually in tax-deferred investment accounts for employees under 50 years of age. Employees 50 and older can contribute an additional $6,000 in "catch up" money in 2018.
  • Both plans allow for employer matches; i.e., dollar-to-dollar contribution matches up to a certain annual contribution level.
  • Withdrawal rules are the same for both 401(k) and 403(b) plans.
  • Loan provisions are the same for both 401(k) and 403(b) plans (loans are allowed for a limited amount, but the IRS will take 10% of the loan amount out in penalties if the loan isn't repaid).
  • Both 401(k) and 403(b) plans have the same rollover provisions when a plan participant leaves one job and take his or her plan to another position. It's worth noting that a 403(b) plan and a 401(k) plan can be rolled over into a traditional IRA, but the IRS frowns upon any rollover intermingling of 401(k) plans and 403(b) plans.
  • Both 401(k) plans and 403(b) plans allow participants to begin withdrawing regularly from their plan accounts after age 59.5, without any tax implications.
  • Both 401(k) plans and 403(b) plans require plan participants to start receiving monthly payments at age 70. If they don't, the IRS can begin issuing penalties.

Key Differences Between 401(k) and 403(b) Plans

While 401(k) plans and 403(b) plans do share several common attributes, their differences can be stark and plan participants should be aware of all distinctions between the two retirement plans, so they don't make incorrect assumptions - and try to take incorrect actions.

Here are the most significant differences between 401(k) plans and 403(b) plans:

  • 401(k)'s have more investment choices than 403(b) plans: By and large, 401(k) plans offer more investment options than their 403(b) counterparts. 401(k) plans can - and do - offer stocks, stock funds, bond funds, money market funds, exchange-traded funds and annuities. 403(b) plans, on the other hand, usually only offer mutual funds and annuities to plan holders. That's primarily to rules drawn up by Congress that limit investment options on 403(b) plans, theoretically to protect plan participants from excess investment risk.
  • 403(b) plans not as regulated as 401(k) plans: Another key distinction between 401(k) plans and 403(b) plans is that 403(b) plans tend to have less regulatory oversight than 401(k) plans. As both plans ran the congressional approval gauntlet at different times, the language in their respective legislation differs (403(b) plans were OKed in 1958). The fact is, 403(b) plans don't operate under the same rules as 401(k) plans (approved in 1978), which are covered by the Employee Retirement Income Security Act of 1974 (known as ERISA), and are overseen by the U.S. Labor Department. With 401(k) plans, employers are held to closer scrutiny by regulators and that's not always the case with 403(b) plans, where plan participants are expected to take on a greater role in managing their investment accounts.
  • Contribution limits can differ: While both plans allow for the same basic annual contribution limits of $18,500 in 2018, 403(b) plan participants can contribute an additional $3,000 to his or her plan if they've been with the same organization for 15 years.
  • Company matches may be lower with 403(b) plans: To remain exempt from ERISA statutes, 403(b) employers usually don't offer matching contribution programs. If they do, their matching contributions are usually lower than with a company running a 401(k) plan matching contribution program.
  • Fees associated with 401(k) plans are cheaper than 403(b) plan fees: Since 403(b) plans tend to relay more on higher-cost investment like actively managed mutual funds and variable and fixed annuities, their fees are usually higher than with 401(k) plans, which can offer lower-cost investment options like exchange-traded funds and index funds.

Differences in Investment Options for 401(k) vs. 403(b)

As noted above, 401(k) plan participants tend to have a larger menu of investment options than 403(b) plan consumers, who are usually limited to choosing from annuities and mutual funds. Besides the number of investments offered by each retirement account, 401(k) and 403(b) plans differ in the fees charged to plan participants. Since 401(k) plans can offer lower-cost index funds and ETFs, plan holders don't pay as much in fees as do 403(b) plan consumers. Those consumers may be limited to using - and paying for - higher fee-charging investment vehicles like mutual funds and annuities.

401(k) plan investment options:

  • Stocks: Individual stocks are usually offered to plan participants through brokerage accounts.
  • Mutual funds: Including stock, bond, international, sector, emerging market, life cycle, and large-cap, mid-cap, and small-cap funds, among other categories. These funds usually come with a higher fee than with index or exchange-traded funds.
  • Exchange traded funds: ETFs offer the same funds as mutual funds do, but usually with lower fees.
  • Money market funds: These conservative funds are tied to money market rates, and are both low-cost and low risk for 401(k) investors.

403(b) plan investment options:

  • Fixed and variable annuities: These investments represent a contract between the annuity holder and insurance companies that offer the annuity. Fixed annuities mean exactly that - they offer annuitants a fixed rate of return on their investment. Variable annuities offer different rates of return, based on the underlying performance of the investment used to house a person's annuity assets (usually a mutual fund or index fund.)
  • Mutual funds:  403(b) plans offer mutual fund shares to plan participants that are purchased straightaway from the mutual fund or from a registered broker. They usually include stocks, bonds and money market funds, and the mutual funds are managed by professional registered investment advisors.

Required Minimum Distribution Options for 401(k) and 403(b) Plans

Largely, minimum distributions are the same for both 401(k) plans and 403(b) plans - but there are some variances.

For example, both 401(k) and 403(b) plans require plan participants to begin taking minimum distributions out at age 70 and a half. The required distributions must begin once the account holder is age 70 ½, regardless of whether the plan participant is retired.

For 403(b) plans, since the cash taken out is after-tax money, required minimum distributions will not boost your taxable income. Additionally, any missed required minimum distributions for both 401(k) and 403(b) plans will trigger a 50% tax penalty of the distribution amount.

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