If you are offered both 403(b) and 401(k) by your employer, you can choose to contribute to both the plans so that you can boost your retirement savings. However, there are certain limits placed on the combined total of the salary reduction contributions that can be made in a financial year. This contribution limit for 2021 is set at $19,500. If you are above 50 years old, you can make a catch up contribution up to $6,500. So if you were wondering what to choose between 403(b) and 401(k), this post will help you make the decision. Let’s get started.
403(b) vs 401(k): All You Need to Know
What’s the Difference between 403(b) and 401(k)?
If you are not self employed, your primary retirement account will most likely be a 401(k) or a 403(b). While these plans are similar in some ways, there are some distinct differences as well, especially if you’re moving from an employer that offers one to an employer that offers the other. Let’s find out some more details.
How does a 403(b) work?
Generally, nonprofits, including schools, hospitals, and religious groups, offer their employees 403(b) retirement accounts instead of 401(k) accounts. A 403(b) account can’t be offered by a for-profit firm. Similar to a 401(k), the 403(b) also lets employees make deposits that are tax deferred. The contribution limit is the same as a 401(k), as well as the withdrawal rules. However, a small and specific subset of employees can enjoy this feature—if you have 15 years of service and your company is considered a “qualified organization,” you may be eligible to contribute an extra $3,000 to a 403(b). This option doesn’t exist in the case of a 401(k). Another manner in which a 401(k) and a 403(b) differ is the choice of investment. While most 401(k) plans come with different mutual funds as their investing choices, 401(k) plans have the option to offer other choices. 403(b) plans can only offer mutual funds and annuities. Technically, 403(b)s are more limited on investing options than 401(k)s but in practice, there’s not much difference.
A 403(b) account is also known for charging higher fees than a 401(k). However, a recent slew of 403(b) plans have started coming with lower fees.
How does a 401(k) work?
A 401(k) is a retirement plan that allows employees of for-profit companies to save for retirement. A long time ago, many companies provided pensions, which were ongoing retirement payments guaranteed by an employer. After the Congress passed the Revenue Act of 1978, Section 401(k) of the tax code was born. Within two years of the IRS issuing proposed regulations sanctioning using employee salary reductions as retirement plan contributions, more than half of all the largest companies started offering 401(k). Over the years, the total amount of money invested in 401(k) has crossed $6 trillion.
A 401(k) is a qualified plan. A qualified plan also gives some tax benefits to the company for contributing money to the account on your behalf. You can also choose to contribute a portion of your paycheck to the plan before the IRS comes in and levies some taxes on the fund.
With qualified plans, you can contribute up to $19,500 in 2020 and 2021. You can’t withdraw money out of most 401(k) plans until you reach age 59 ½ or meet certain IRS conditions, and you have to begin taking withdrawals by age 72, or 70 ½ if you reached that age before January 1, 2020. Roth 401(k) plans have different rules.
401(k)s and other company-sponsored retirement plans also limit the investment choices you have. Unlike an IRA, which allows you to choose between a gamut of investing products, the average 401(k) plan in 2016 came with only 27 options. The high fees also tend to eat into your balance. Depending on your plan’s quality, you might be forced to have less than ideal options as it pertains to fees.
403(b) vs. 401(k): Which is Better?
For the majority of employees engaged in the current workforce, the type of plan doesn’t really matter. However, the 403(b) might be able to offer some benefits to non profits.
Instead of evaluating a 403(b) versus a 401(k), you must analyse and evaluate the investment options contained within the plan. Generally, the larger the company, the lower the plan fees. This is because more people participate in it, lowering the cost. If you work for a small company, you should seek lower cost index funds as an investment option instead of investing in highly expensive actively managed funds.
If your company matches your deposits, you will be better off participating in the plan up to the maximum amount they’ll match. Once you do that, you should open an IRA in case the plan’s fees are very high. You can also choose to do this in case you want to diversify your investments to options that are not available in either 403(b) or 401(k).
So that was a brief look into the world of 401(k) and 403(b). Hopefully, it will be easier for you to make a choice between the two after you’ve read this post.