INVESTINGBUDGETING

Comparing Retirement Plans: 401(k) vs. 403(b)

Although they sound similar, 401(k) plans and 403(b) plans have key differences even though both are retirement savings accounts. The type of company you work for determines which one is offered to you by your employer. A 403(b) plan is for nonprofit organizations including schools, universities and churches, as well as specific government employers. A 401(k) plan, in contrast, is offered by private, for-profit companies.

Investing Options

If you have a 401(k) plan through your employer, you may have a traditional 401(k) option or a Roth 401(k) option. According to Forbes, with a traditional 401(k) plan, your contributions come out of your paycheck before income taxes, which decreases your current taxable income. You will pay taxes on any withdrawals you make in retirement. If you choose a Roth 401(k), you will pay income taxes on your contributions as you make them, so you owe no income tax on withdrawals in retirement. Regardless of which 401(k) plan you choose, your money grows tax-free, and your investment gains are not subject to capital gains taxes. A 403(b) plan also offers a traditional and a Roth option and grow tax free.

While both 401(k)s and 403(b)s utilize mostly mutual funds for investing and allow employees to have some choice in the investments they select, 403(b)s typically offer fewer options than 401(k)s. With a 401(k), employees usually choose from a mix of stock and bond funds, target date funds, or invest in some annuities. With a 403(b), employees can choose from mutual funds or annuities, which means they typically have fewer options and flexibility than they would with a 401(k).

Employer Contributions

Another difference between a 401(k) plan and a 403(b) plan is the opportunity for employer contributions. A 401(k) match is a benefit offered by many employers. A 401(k) match is when your employer contributes up to a specific percentage of your income based on what you contribute to your retirement plan. For example, MSU Federal Credit Union and OU Credit Union offer a 2:1 match to full-time staff, which means the institution matches $2 for every $1 contributed by an employee up to 4% of that employee’s gross income. In addition, the credit union contributes 2% regardless of whether the employee is contributing or not. Other companies may match up to 50% of what an employee contributes, or they may match 100% of what an employee contributes up to a certain percentage of the employee’s salary. Although employer contributions can occur with 403(b) plans, they are less common due to many nonprofit companies opting out of the Employee Retirement Income Security Act (ERISA). If employers comply with ERISA, they may offer a 403(b) contribution with a vesting period that is often shorter than it would be with a 401(k).

Employee Contributions

One similarity between a 401(k) and a 403(b) is the contribution cap per year is the same for both plans. So, if you were in a rare instance where you utilized both a 401(k) and 403(b), your total contributions to both accounts combined cannot exceed the annual limit for that year. Oftentimes, there is an annual limit for those younger than 50, and a slightly higher limit for those 50 or older. Make sure to research this each year to ensure you’re maximizing your savings and not exceeding the annual contribution cap. While both plans typically have the same contribution limits, 403(b)s do have a unique perk. According to Forbes, employees who have worked for a qualified organization for 15 years or more may be eligible to make additional contributions. For example, in 2023 qualifying employees could contribute up to $3,000 more annually for up to five years.

In conclusion, 401(k) plans and 403(b) plans are both great options. It’s important to know what types of investment opportunities you have with each type of plan so you can make the most of your money in preparation for retirement. Both plans allow you to diversify funds and reap the rewards of compound interest over time. Taking advantage of whichever one your employer offers and making consistent contributions is key to reaching your financial goals for retirement. If your employer offers a match, that’s even more of a reason to utilize your 401(k) or 403(b) to maximize your savings. Understanding retirement plans can feel confusing but gaining clarity regarding 401(k)s and 403(b)s can help you begin saving for retirement confidently.

Sources:

https://www.forbes.com/advisor/retirement/403b-vs-401k/

https://www.investopedia.com/ask/answers/100314/what-difference-between-401k-plan-and-403b-plan.asp#:~:text=401(k)%20plans%20can%20be,may%20also%20choose%20to%20contribute

https://www.usatoday.com/money/blueprint/retirement/401-k-vs-403-b/