403(b) vs. 401(k)

Saving for retirement comes with a lot of questions: How much do I need to retire? When should I retire? Will my employer help me get there? What kind of retirement savings account should I get? On that front, there are many options to choose from.

For those who aren’t familiar, 401(k)s and 403(b)s both offer a way to save for retirement. But there are specific differences you should be aware of. Here’s what you need to know.

A 401(k) is an employer-sponsored retirement plan. Typically, you contribute to this on a monthly basis, and the cash is taken out of your paycheck. Many companies will also offer an employer match for 401(k)s, which is often set as a percentage of your contribution. For example, your employer might offer a 100% match up to 5% of your salary. Essentially, that’s free money for retirement.

When you contribute to a 401(k), that money is usually deductible from your taxable income, but you do have to pay taxes on it once you start withdrawing funds in retirement.[1] There’s also a 10% tax if you take out money before you turn 59 ½. There are some exceptions, including:

• Severance or separation from service

• Payments to someone else a qualified domestic relations order

• Payments for medical care (though the amount is limited)

• Disability

• IRS-approved disaster relief

• Death[2]

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A 403(b) is a tax-sheltered annuity plan offered by public schools and some tax-exempt organizations which allows those employees to save a percentage of their income for retirement.[3]

“It is a retirement account that allows you to put money away, either pre-tax (traditional) or post-tax (Roth),” says Jay Zigmont, a Certified Financial Planner and founder of Childfree Wealth in Water Valley, Miss. “Your employer may make a match contribution to your 403(b) just like a 401(k), or not.”

Like a 401(k), if you take your money out of a 403(b) before you are 59 ½, you will have to pay a 10% penalty. There may be exceptions, however, in the following circumstances:

• Financial hardships

• Severance

• Disability

• Death[3]

“A 403(b) is like a 401(k), but it is only for non-profits and governmental employees. As an employee, a 403(b) works much the same as a 401(k),” says Zigmont.

However, the two accounts aren’t necessarily on equal ground when it comes to flexibility. And 401(k)s typically offer a bit more in terms of investment options (with options like stocks, mutual funds, bonds, and other securities), while 403(b)s may be limited to mutual funds and annuities.[4,5]

At the same time, 403(b)s may have higher fees, says Eric Phillips, a Chartered Financial Analyst at Human Interest, a retirement savings provider.

“This, in combination with the fact that many organizations don't have a lot of options when it comes to 403(b) providers, means that many of the current 403(b) plans currently in existence offer employees a confusing set of high-fee funds,” he says.

And then there are differences in how much you can contribute.

With both 401(k)s and 403(b)s, you can contribute up to $20,500 per year.[6] Both plans also offer catch-up contributions for those over 50, limited to $6,500 per year.[7]

However, 403(b) plans have an additional catch-up contribution option that isn’t available to those with a 401(k). You can contribute up to $15,000 under that catch-up rule as long as you’ve worked for the organization for at least 15 years.[8]

Although 401(k)s and 403(b)s are both retirement accounts, they aren’t typically going to be offered to the same people. That’s because 401(k)s are an option from for-profit companies, while 403(b)s are for non-profits and certain government employees. You also cannot open a 401(k) or 403(b) on your own as someone might open an individual retirement account (IRA)—it has to come through your employer.[9]

So ultimately, although there is some overlap here, it’s not really a question of which is better since you probably won’t be in a situation where you have to choose between the two. It’s about making sure that you put enough money toward your retirement. (In fact, both 401(k)s and 403(b)s allow for automatic enrollment.)[1,3]

If you are looking to maximize your retirement savings, though, you should know that you may be able to open an an IRA to stash away extra cash—even if you have a 401(k) or 403(b).[10,11] IRA contributions are limited to $6,000 per year (or $7,000 if you’re 50 or older).[12]