If you’re starting a new job, there’s a good chance you’re going to have the option to join an employer-sponsored retirement plan, and it’ll probably be one of two types of plans: a 403(b) or a 401(k). Both are defined contribution plans. Employees who participate in the plans choose how much to put into their account each month, and the payout in retirement is determined based on how much they save during their careers. This article will take a look at both plans, comparing 403(b) vs. 401(k).
Though 401(k) plans and 403(b) plans are similar in many ways, there are a few key differences you should know if you’re about to start a new job where one of these plans is offered, especially if you’ll be contributing to one type of plan after having participated in the other at a previous company.
403(b) vs. 401(k): Similarities
Let’s start by taking a look at the similarities between a 401(k) plan and a 403(b) plan. Companies sponsor both types of retirement plans. Employees join the plan if they want to save for retirement, and the company may also offer to match employee contributions up to a certain limit. The money is then invested into investment vehicles such as mutual funds. The end goal is that the market (hopefully) grows steadily throughout your career and you have saved a tidy nest egg for when you retire.
Employees contribute pre-tax money in both 401(k) plans and 403(b) plans. When an employee eventually retires, they pay income tax on the money as it is withdrawn from the plan. This has a couple of implications: First it means that by contributing to one of these retirement plans, you are lowering your taxable income now. Secondly if you expect to be in a lower tax bracket come retirement, this would mean that the tax burden for the money you invest is less than it would have been if you’d paid taxes when you earned it.
The same rules for maximum contributions govern both types of plans. The maximum amount you can contribute to either a 401(k) or a 403(b) in 2018 is $18,500. This is cumulative, so if you switch jobs mid-year you can contribute a total of $18,500 to all defined contribution plans you have access to in a given year. The contribution limit for both plans increases by $6,000 for employees over 50 in both plans.
Both plan types also allow for early withdrawals, but not without penalty. Fees and fines are applied to those wishing to take money out of either kind of retirement plan before age 59 1/2 (or in some cases age 55).
403(b) vs. 401(k): Differences
There are some noteworthy differences between a 403(b) vs. a 401(k). The most important is the types of companies that offer the two plans. For-profit companies offer 401(k) plans. Most people work at for-profit companies, meaning the majority of retirement plan participants use a 401(k.) Not-for-profit and public sector institutions, meanwhile, use 403(b) plans. If you work at a charity or at a government entity like a school or a municipal department, you may have the ability to invest through a 403(b.)
The Employee Retirement Income Security Act of 1974 (ERISA) governs all 401(k) plans. Some 403(b) plans are subject to the same law, but not all. Essentially, if you work at a private not-for-profit company like a charity or think tank, your plan is subject to ERISA. If you work in a public sector job like a school system or public university, though, your plan is not subject to ERISA regulations. ERISA protects plan participants and guarantees certain rights. Make sure to know whether or not your plan is subject to the law.
Participants who have been employed at a not-for-profit entity for more than 15 years may find another difference between the two plan types that plays to their benefit, especially if they were derelict in planning for retirement early in their careers. Employees who have been with the company for more than 15 years can make extra contributions beyond the 403(b) contribution limit. One caveat: this is only relevant to some 403(b) plans. The company or municipality that sponsors the plan has to choose to offer it as a feature.
The Bottom Line
Generally, you don’t have a choice between a 401(k) and a 403(b.) The type of company you work at determines which type of plan you have access to. Whichever you use, though, you’ll be getting the same basic experience. You’ll choose how much money to contribute from each paycheck. The money goes into your account pre-taxes, and you pay taxes when you withdraw it in retirement. There is a limit to how much money you can contribute with a 401(k) and a 403(b), and your employer may match a percentage of your contributions. The differences between the two types of plans might not even impact you much, unless you’re an older worker.
Saving for retirement is important no matter which plan you have access too, so don’t worry so much about which type of plan you have access too – focus instead on getting the most out of your money in preparation for your life after work.
Retirement Planning Tips
- Know your path: Figure out early how much money your retirement plan will be worth when you retire. If you know approximately how much money you’ll have in your plan when you’re ready to retire, you’ll know if you’re on track for your goals or if you need to boost your savings a bit.
- Get some help: Think about getting a financial advisor to help guide you. A financial advisor can help you make the best investments and will help you make choices about how to meet your retirement goals. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
- Remember the limits: Keep in mind that there are also IRA contribution limits. Knowing the maximum you can donate to your account is key to your planning.
- Consider other options: A Roth IRA might be a good way to supplement your savings. Roth IRAs are funded with post-tax money, so when you withdraw from the account in retirement, you’ll be able to do so without paying taxes. This can be a great option if you anticipate being in a higher tax bracket in retirement than you’re in now.
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