401(k) vs. 403(b): Key Differences and Choosing the Right Retirement Plan

Planning for retirement is an important part of financial well-being, but sometimes, it’s hard to know which retirement plan is best for your situation. Let’s look at two popular types of retirement plans offered by employers: 403(b) and 401(k). We’ll discuss the differences between these two plans so that you can make an informed decision based on your financial goals and circumstances.

At a glance:

• 401(k) plans are common in for-profit companies and offer more investment options.
• 403(b) plans are for non-profits and government employees. These plans focus more on annuity options for stable retirement income.
• Both plans have similar rules for early withdrawals and penalties.

What is a 401(k) plan?

A 401(k) is an employer-sponsored retirement plan that allows you to contribute part of your pre-tax income toward retirement. Private-sector employers commonly offer these plans, but some government and non-profit organizations also offer them. Two common types of 401(k) plans are traditional and Roth. Each plan type has its own tax advantages:

• Traditional 401(k): Contributions to a traditional plan are tax-deferred, meaning you do not pay taxes on your contributions until you withdraw it in retirement. This is the most common type of 401(k) plan employers offer. Your contributions are taken out of your paycheck before taxes, so every contribution you make lowers your annual taxable income.
• Roth 401(k): In contrast, contributions to a Roth plan use after-tax income. While contributing to a Roth 401(k) won’t lower your taxable income right away, you won’t have to worry about paying taxes on your distributions in retirement — your withdrawals will be tax-free.

What is a 403(b) plan?

A 403(b), or tax-sheltered annuity plan, is another type of retirement savings account. These plans are typically available in non-profit organizations, public schools, and certain other tax-exempt organizations. Just like a 401(k), 403(b) plans can include a traditional and Roth option:

• Traditional 403(b): Contributions to a traditional plan are tax-deferred, just like a 401(k). Your employer takes pre-tax contributions out of your paycheck, reducing your taxable income. You won’t need to pay taxes on the money until you make a withdrawal.
• Roth 403(b): Contributions to a Roth plan use post-tax money, meaning you won’t have an immediate tax advantage, but you won’t owe any taxes on that money when you make a qualified distribution.

Key differences between 401(k) and 403(b) plans

Employer types

The biggest difference between these two retirement plans is the types of employers who offer them. For-profit employers, such as small businesses and corporations, typically provide 401(k) plans. In contrast, 403(b) plans are usually available to non-profit organizations or government employees — teachers, doctors, nurses, church staff, librarians, etc.

Eligibility criteria

Eligibility for 401(k) and 403(b) plans may vary based on employment status, length of service, and employer policies. To determine eligibility, make sure to review your employer’s plan documents carefully.

Contribution limits

The IRS sets annual contribution limits for both 401(k) and 403(b) plans. As of 2024, the annual contribution limit for both plans is $23,000, up from $22,500 in 2023. You can contribute an additional catch-up contribution of $7,500 per year if you are age 50 or older, making your total annual limit $30,500 for 2024.

Investment options

Both accounts allow plan participants to save and invest part of their paycheck before taxes are taken out. While 401(k)s and 403(b)s share similarities, they also have distinct features, particularly in the range of investment options they offer.

A 401(k) can offer various investment options, such as stocks, bonds, mutual funds, and target-date funds. A 403(b) plan has more limited investment options. They may also offer certain mutual funds, but this type of plan is mostly known for its annuity options. Annuity contracts allow you to make a lump sum payment (or series of payments) to an insurance company in exchange for guaranteed fixed payouts in retirement. These can be attractive if you value predictability and want a stable source of retirement income without worrying about stock market performance.

Matching contributions

Many employers, but not all, offer matching contributions as part of their retirement plans. In 401(k) plans, employers may match a percentage of your contributions up to a certain dollar amount or percentage. Similarly, some 403(b) plans may offer employer contributions, although the matching structure may differ from 401(k) plans.

Vesting

Vesting is when you gain ownership of employer contributions to your retirement account. Your own employee contributions are always 100% vested, but employer contributions may work differently. Vesting schedules can vary in both 401(k) and 403(b) plans. Some employers offer immediate vesting, while others have vesting schedules:

• Immediate vesting: If your plan offers this, you are immediately 100% vested in any employer contributions without having to wait.
• Graded vesting: With graded vesting, your percentage vested increases every year you stay with your employer. The maximum time limit for becoming fully vested is six years of service. For example, you may start out with 0% vested the first year and gain 20% every year until 100% vested the sixth year.
• Cliff vesting: Instead of gradual vesting, cliff vesting makes you wait a certain amount of time before gaining ownership of your employer’s contributions all at once. The maximum time limit for cliff vesting is three years. For example, you might be 0% vested in the first two years and 100% vested in the third year.

If you leave a company that uses a vesting schedule for your 401(k) or 403(b), you may forfeit any employer contributions that are not yet fully vested.

Withdrawal rules

Both 401(k) and 403(b) plans have rules regarding early withdrawals, including penalties for withdrawing funds before reaching age 59½. However, both plans may have additional withdrawal options for certain circumstances, such as loans and hardship withdrawals for specific financial needs.

The IRS generally requires you to take required minimum distributions (RMDs) from traditional 401(k) and 403(b) plans once you hit age 72 (or 73 if you turn 72 after Dec. 31, 2022). Beginning in 2024, RMDs are not required for Roth 401(k) or 403(b) plans.

How to choose between a 401(k) and a 403(b)

You may need to choose between these accounts if you work for multiple employers. If you’re unsure which to go with, consider your risk tolerance and preferred investment options. A 401(k) offers more diversity, but a 403(b) can be appealing if you’re interested in annuities. Both are generally good retirement planning options, but the best choice for you ultimately depends on your financial goals. If you’re still unsure which plan is right for you, a financial advisor is always a good option — they can provide personalized guidance based on your unique circumstances.

You can contribute to both types of plans, but note that your combined contributions can’t exceed the annual limit ($23,000 for 2024).

The bottom line

Both 401(k) and 403(b) accounts can be good retirement savings plan options with valuable tax benefits. When deciding between the two, the most important factors to consider are the difference in investment choices, eligibility criteria, and potential employer match. It’s a good idea to carefully review both options and read the fine print to determine which plan best fits your retirement goals.

Tax Tip: If you are self-employed, check out How to Save for Retirement When You’re Self-Employed.

This article is for informational purposes only and not legal or financial advice.

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