For hopeful retirees looking for ways to make the most of their retirement plans from their employer, comparing the 403(b) vs 401(k) benefits can help.
In this article:
- 401(k) and 403(b): Retirement Savings Plans for an Employee
- What Does a 401(k) Do for an Employer and Investor?
- How Does a 403(b) Work?
- What Is the Difference Between 401(k) and 403(b)?
- What Plan Will Work for You?
403(b) vs 401(k): What They Are, Investment Options, How They Help with Retirement Income
401(k) and 403(b): Retirement Savings Plans for an Employee
Retirement plans can form part of the early retirement secret for successful retirees. And the good thing is, you can get a retirement plan from your employer.
Employees working for for-profit companies can qualify to invest their money in a 401(k) offered by their employer.
According to the IRS 401(k) plans qualification resource, generally, an employee who has worked for the same employer for at least a year and is at least 21 years old should be allowed to contribute to an employer-sponsored plan.
Important: Some traditional 401(k) accounts may require two years rather than just one year. It’s best to ask your employer just to be certain.
Lastly, a qualified retirement plan can include a 401(k) only if it’s a:
- Stock bonus plan
- Rural cooperative plan
- An account or plan that includes profit-sharing from the employer, or
- A money purchase pension plan from June 24, 1974
On the other hand, you generally can invest your money in a 403(b) only if you work for non-profit organizations.
Specifically, employees working in public schools or school districts, ministries, or tax-exempt organizations can invest in a 403(b).
Due to the US tax code restrictions on 403(b) plans, only a select few employers can offer employees a 403(b) plan.
What Does a 401(k) Do for an Employer and Investor?
Hopeful retirees can appreciate a 401(k), especially if they start investing for retirement while young.
Employers give a matching contribution to a 401(k) not only because of generosity. Knowing how a 401(k) provides value to an employer can be useful especially if you want to convince an employer to do matching contributions.
Matching a 401(k) contribution makes an employer’s life easier since:
- It makes it easier to prove non-discrimination in retirement plans for the employer. This proof is immensely useful for employers with a lot of employees, just in case some labor or IRS cases are filed against them due to discriminatory retirement plans.
- Matching contributions can actually benefit the employer through tax benefits. Up to a certain point, employer contributions are tax-deductible.
- Lastly, 401(k) contributions pass the burden of retirement investing from the employer (like pension plans) to the employee. That saves a lot of time and resources for an employer, as managing a pension takes money and personnel to administer properly.
Of course, top talents would also love to remain in a company that values them.
If you haven’t received matching contributions, then try explaining how an employer can actually save money from taxes. Matching contributions aren’t compulsory, so persuading your employer to match contributions can really help you contribute more to a retirement nest egg.
For an investor, a 401(k) allows assets to grow with tax benefits. While the money is in a 401(k), no taxes are paid for any growth.
A taxpayer pays taxes either before putting it in (such as post-tax Roth contributions) or just pay taxes when you withdraw funds (pre-tax like a Traditional IRA).
Lastly, contributing to a 401(k) reduces your taxable income. That can mean saving money in taxes as well as ensuring that you will have assets and retirement income.
Of course, a 401(k) plan has investment classes limits. Generally, a 401(k) is a custodial account managed by a custodian.
Usually, a 401(k) usually invests your money in mutual funds, stocks and bonds, or debt-based investments. A 401(k) generally won’t invest in other more speculative investments.
How Does a 403(b) Work?
Just think of a 403(b) as a 401(k) retirement plan for employees of organizations that are tax-exempt.
While most local government workers have a state pension already provided, some may want to have a 403(b) set up for more retirement income diversification.
Like a 401(k), a 403(b) plan can give tax-deferred growth of your retirement nest egg. Like most 401(k) plans, a custodian or fund manager makes the investment decisions and asset allocation.
Of course, early withdrawals, unless qualified, also lead to penalties. Any contributions can also lower the taxable income, which can save taxes and in turn increase funds for investing.
Just a heads up, a 403(b) can still legally accept matching contributions from an employer. However, employers rarely do so due to some prohibitions (such as profit-sharing plans not being allowed for a 403(b) that can affect the employer.
Usually, people in the financial industry call a 403(b) as a tax-sheltered annuity, like most managers of 403(b) structure the retirement plan as an annuity.
An annuity is a plan wherein an investor gets the benefits while he or she is still alive and qualified to receive the remaining money in the annuity.
What Is the Difference Between 401(k) and 403(b)?
Legally speaking, a 403(b) can’t accept a profit-sharing plan. This prohibition is actually logical, as the employer should operate not for profit but for giving out services to the public.
For a 401(k), a profit-sharing plan is one of the most common ways employers contribute to the employee’s account.
Another interesting difference between a 403(b) and a 401(k), again, due to the law, is the lack or presence of the non-discrimination test for retirement plans.
A non-discrimination test refers to an administrative test process from the IRS to check unfair investment practices. The test basically minimizes the opportunity of high-level executives to unfairly increase their retirement eggs without giving other employees the same benefits.
A 403(b) plan doesn’t have any non-discrimination test. That means lower administrative proof on part of the employer.
As you can see, a 403(b) plan has lesser administrative work internally. This advantage also benefits investors in the form of lower administrative fees compared to a 401(k).
A common distinction between a 401(k) and a 403(b) is with asset allocation.
A 401(k) commonly invests in stock equity. However, managers of the 401(k) usually only allow a set percentage of the 401(k) to invest in a stock the investor chose.
403(b)s usually just invest in safer and less volatile investment vehicles. Typically, a 403(b) will act as a fund of funds, where the fund invests in mutual funds that has an investment in other mutual funds. A 403(b) can also usually be an annuity.
401(k)s usually have the structure of an IRA wherein an investor simply contributes and let the competent managers work.
What Plan Will Work for You?
Actually both can work. If you can possibly get both, that’s much better.
However, do note that if an employer has a 401(k) or 403(b) plan for some employees, then all employees should also have the right to participate. Of course, employees can affirmatively opt-out.
While theoretically, a 401(k) and 403(b) has the same investment options applicable legally, a 403(b) usually goes for a more conservative mix (like debt-based assets and mutual funds) compared to a 401(k) which can invest in highly liquid investments like stocks.
The debate between a 403(b) vs 401(k) plan is an important one. However, choosing the appropriate plan does not mean that you can reach your retirement goals; this is simply the first step towards your rich retirement life.
Have you chosen which plan you will go for? Do you know any other differences between 403(b) vs 401(k)? Let us know in the comments section below.
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