401(k) versus 403(b): guiding clients through retirement plan choices 

For building their retirement savings, investors have many options. There are many employer-sponsored retirement accounts, and the 401(k) plans and 403(b) plans are just two examples. Of the two, the 401(k) is the more popular and more familiar. Meanwhile, the 403(b), even if lesser known, has its merits.   

Some of your clients may wonder whether they should choose between the 401(k) or the 403(b) for building their retirement funds. They wouldn’t need to make that choice.  

The 401(k) is an employer-sponsored plan offered by companies in the private sector, meaning for-profit companies, while the 403(b) is the employer-sponsored plan offered by public-sector companies, public schools, churches, and non-government, non-profit organizations.  

Whether an employee gets a 401(k) or a 403(b) is a matter of their types of employers. Deciding between either of these plans is not an issue, but it’s still inevitable for some employees to make comparisons.  

So, what’s the difference between 401(k) and 403(b) plans? Are there benefits to a 403(b) versus the 401(k)? In this article, InvestmentNews provides some insight as to which is better, the 401(k) or the 403(b).  

The 401(k) and 403(b) plans 

What are the 401(k) and 403(b) plans? As previously mentioned, both are employer-sponsored retirement plans. Here are some facts about the plans:  

The 401(k) plan 

• established in 1978, the 401(k) plan was made possible by passing the Revenue Act of 1978, which created the Internal Revenue Code Section 401(k) 
• the name 401(k) comes from the IRS section 401(k) governing the plan 
• employees of for-profit, private sectors companies can use this retirement plan 
• businessman Ted Benna is credited with being the first person to use the 401(k) as part of his company’s benefits package 
• Benna aggressively campaigned for more businesses in the US to use the 401(k), even working as a consultant to US Congress   
• Benna interpreted the Revenue Act in a way that let employees save pre-tax contributions in a retirement account, while also receiving matching contributions from employers. For his efforts, he was unofficially named “The Father of the 401(k)” 

Should there be government site for all your 401(k) data? The Government Accountability Office wants Congress to mandate a national 401(k) dashboard https://t.co/ZzBwVRCPEM #InvestmentNews @EmileHallez #retirement #401k pic.twitter.com/jD3PvGDNG6

— InvestmentNews (@investmentnews) February 23, 2024

The 403(b) plan 

• this is a retirement plan for employees of non-profit organizations, public schools, hospitals, churches, and other tax-exempt organizations 
• self-employed ministers and church employees may also use the 403(b) 
• 403(b) plans were meant to serve as a relatively simpler way for employees to supplement retirement savings with their voluntary contributions of pre-tax dollars 
• employees can choose their own advisor and investments 
• the 403(b) plan allows for multiple investment providers 
• public education employers were given the option of issuing 403(b) plans in 1961, with investments limited to annuities 
• mutual funds held in custodial accounts were added in 1974 to 403(b) plans 
• now, there is roughly $1 trillion in 403(b) assets that are held in individual accounts; these are held mostly in annuities or in mutual funds 

The 403(b) universal availability rule 

This rule states that if an employer allows one of their employees to contribute to a 403(b) plan, the employer must extend this offer to all other employees. However, there are some exceptions. The employer reserves the right to exclude certain employees from the plan, including:  

• those who will contribute $200 or less annually 
• those who already have a 401(k) or 457(b) plan or another 403(b) plan of the same employer 
• non-resident aliens 
• employees who typically work less than 20 hours per week 
• students performing services described in IRC Section 3121(b)(10) 

What are the eligibility requirements for the 401(k) and the 403(b)? 

In most cases, an employee is eligible for their employer’s 401(k) if they: 

• are at least 21 years old 
• have been with the company for at least a year 

These are the minimum eligibility rules outlined by the IRS. If an employer wants different rules for their 401(k) plan eligibility, the rules must be in the plan document and can only be less restrictive, not more.  

The 403(b), aka the Tax-Sheltered Annuity plan (TSA), must be issued by eligible employers such as: 

• public schools 

• colleges 
• universities 
• churches 
• charitable entities that are deemed tax-exempted by Section 501(c)(3) of the IRS 

Eligible employees include:  

• those employed by tax-exempt organizations compliant with IRC Section 501(c)(3) 
• public school employees involved in the school’s day-to-day operations 
• those employed by cooperative hospital service organizations 
• Uniformed Services University of the Health Sciences (USUHS) civilian faculty and staff 
• those employed by public schools organized by Indian tribal governments

Similarities of 401(k) and 403(b) plans 

These two retirement plans share a lot of features and have some differences as well. Here are some of the main similarities they have:  

Tax benefits 

Both the 401(k) and 403(b) share the same tax advantages: they allow contributions with tax-deferred money. In simpler terms, employee contributions from their paychecks are not yet taxed.  

With this setup, workers enjoy the privilege of paying a lower income tax for that year. The money can then grow tax-deferred within the account, and employees don’t pay income taxes on the money until they make withdrawals during their retirement. 

Another tax benefit that some 401(k) and 403(b) plans can have in common is taking in Roth contributions. Instead of being made pre-tax, Roth contributions are made after an employee has already paid taxes on their income. By putting Roth contributions into these plans, any investment growth and distributions from these accounts become tax-free. 

Employer matching feature 

For both the 401(k) and 403(b) plans, employers may give matching contributions. This means that a company can promise to match each worker’s retirement contributions up to 5% of their wages.  

In finance, this is what advisors like to refer to as the employer match or 401(k) match, since the 401(k) is more popular. Some advisors will say the employer match is the main reason why the 401(k) (and perhaps the 403(b)) is one of the best investments you can make.  

Contribution limits 

The contribution limits for the 401(k) and 403(b) plans are the same. In 2024, the limit is set by the IRS at $23,000. For the catch-up contribution to the 401(k) and 403(b) for employees aged 50 and older, it’s pegged at $7,500 for 2024. 

For 2024, the contribution limit for employees who participate in 401(k) plans, increased to $23,000, up from $22,500. See details from #IRS at: https://t.co/Dmmxa5dYrU pic.twitter.com/KxHvcgE9vN

— IRSnews (@IRSnews) January 14, 2024

Penalties for early withdrawals 

Since both the 401(k) and 403(b) are designed to encourage employees to save for their retirement, they both feature penalties for withdrawing money prematurely. For both accounts, any withdrawals made before the plan owner turns 59½ are slapped with a 10% penalty tax. That may seem small, but the penalty tax is imposed with any additional income tax for making these non-Roth withdrawals. 

The best way to avoid these penalties is to not make an early withdrawal. Or, at the very least, make sure to make qualified early withdrawals only, meaning they are for an urgent need. Read our guide on 401(k) withdrawal strategies for more. 

Required minimum distributions (RMDs) at a certain age 

Finally, both the 401(k) and 403(b) have mandatory distributions that account owners must take by the time they reach a specified age. RMDs enable the IRS to collect income tax on tax-deferred money placed into these accounts.  

At present, investors must take RMDs starting the year they reach age 73 (previously age 72 in 2022 and earlier years). The amount each person must withdraw each year is based on their account balance and their projected life expectancy. The higher the account balance and the older the plan holder is, the more they’ll have to withdraw every year. Investors who take RMDs will have to pay income taxes on them. 

Investors who don’t take their RMDs for the year will pay a 50% excise tax on the required amount that wasn’t withdrawn. For example, if an investor had a $15,000 RMD for the year and only withdrew $7,500, they would have to pay the 50% excise tax on the remaining $7,500. 

Differences between the 401(k) versus 403(b) 

Now, these are the main differences between these two retirement accounts: 

Who can use these retirement plans 

The most important difference lies in which types of companies can use the 401(k) and the 403(b). The 401(k) is available to private sector, for-profit companies while the 403(b) is reserved for public, non-government, non-profit organizations.  

Employees in a corporate setting can expect to have a 401(k) as part of their benefits package. Those who work in churches, public schools, hospitals, or other organizations under section IRC 501(c)(3) of the IRS can expect to obtain the 403(b).  

The investment choices 

The 401(k) plan typically has a wide range of investment options, including:  

• mutual funds 
• ETFs 
• stocks 
• bonds 
• alternative investments 

The 403(b) plan has a very limited range of investments. As per federal law, this type of retirement account can only invest in:  

• annuities 
• mutual funds 

Added contributions 

What’s unique about the 403(b) is that it’s possible to make additional contributions apart from the catch-up contribution. This is an added catch-up contribution plan holders can make if they were employed at the same company for a minimum of 15 years. Employees with that length of tenure are allowed to make this additional contribution to their 403(b) every year as long as it’s the lesser of:  

• $3,000 
• $15,000 minus any additional elective deferrals made in previous years 
• $5,000 times their years of service minus their total elective deferrals made in previous years 

If the employee is 50 years old or older and has rendered at least 15 years of service, they have the privilege of using both available catch-up contributions. 

Here’s a comparison chart for 401(k) versus 403(b) plans: 

Feature	401(k)	403(b)
Automatic Enrollment	Yes	Yes
Roth contributions	Allowed	Allowed
Employer matching	Yes	Yes
Account rollovers	Yes	Yes
Plan document	Required	Required, but steeple churches/Qualified Church-Controlled Organizations can be exempted
Investment options	Almost all types of investments available, with a limit on life insurance policies	Limited to annuities and mutual funds; 403(b)(9) church retirement income accounts can have more options. Life insurance policies before 9/24/07 are grandfathered into 403(b)
Plan-to-plan transfers	Not allowed	Allowed from one 403(b) plan to another if both plans permit
Contributions	Up to $23,000 in 2024. Limit is combined with other 401(k) and 403(b) plans.	Up to $23,000 in 2024. Limit is combined with other 401(k) and 403(b) plans.
Employer eligibility	Sole proprietorships, corporations, LLCs, nonprofit organizations, Indian tribal governments	Nonprofit organizations classified under IRC 501(c)(3)
Early withdrawal penalties (made before age 59½)	Yes; 10% penalty tax in addition to appropriate income taxes	Yes; 10% penalty tax in addition to appropriate income taxes
Additional catch-up contributions	None	Yes, with conditions
Tax benefits	Taxes deferred until taking RMDs in retirement	Taxes deferred until taking RMDs in retirement

The 401(k) versus the 403(b): which should your client choose? 

Truthfully, your client does not get to choose between the 401(k) or the 403(b) – at least not directly.  

Whether they get a 401(k) or 403(b) depends on the nature of their profession and the career path they choose. If they go corporate, they get the 401(k). If they choose to work in a government, church, or nonprofit organization, then they get the 403(b). It’s important to remember that not all companies or organizations offer plans.  

Here’s a short video underlining some of the most obvious differences between the two plans. A few differences of the 401(k) versus 403(b) plans: 403(b)s do not need to have nondiscrimination testing. They also do not allow for profit-sharing. Watch the video for more on the nuances of both plans.  

Both plans have a lot of similarities and very few differences. Picking one over the other may not impact your clients’ retirement savings that much, either way. However, the 403(b) has less limited options for investments. This means there’s the possibility that a 401(k) would provide more tax-free growth and therefore a larger retirement fund versus the 403(b).  

Choosing between the 401(k) or the 403(b) will likely take a back seat to what your clients want to do for a living. Even then, your clients should think about their differences, features, and how they might impact their financial goals, needs, time horizon, and risk appetite before taking that job opportunity. If they can, they should also take advantage of other investments now to bolster their retirement savings or income.