Every employee wants to take advantage of workplace retirement plans. This is because they are great for saving money on taxes and help build up your retirement package. Employer plans typically come in variant flavors and odd names like 401k and 403b, and there are misconceptions about 401k vs 403b that should be cleared up by providing an accurate differentiation of the two. Once you know more about 401k vs 403b, you will know the differences in major aspects, such as eligibility, contribution limits, investments options, deductions and deferrals, and loan provisions for each plan.

What Is 401k vs 403b

401k Plan

Many people are familiar with 401k plans, because they are much more common than 403b plans. Employers who set up 401k plans allow the employees to set aside a portion of their paychecks for retirement. The employers implement this on a pre-tax basis using traditional 401k accounts. Sometimes, employers can implement the plan on an after-tax basis so long as the plan has a Hoth 401k option.

There are ample annual limits that apply to the 401k. Those aged below 50 contribute up to $17,500 and those aged above 50 are allowed to save $23,000. The assets within the 401k plans grow tax-deferred, which shelters you from taxes on the investment income the assets generate over the course of your employment.

403b Plan

403b plans are less common than 401k plans. This is because Section 403b of the IRS, on which 403b plans are based, limits the eligibility of workers in tax-exempt organizations, such as religious groups, hospitals, and schools. However, both have similar contribution limits and tax-deferred benefits.

Can You Choose The Plan of Your Preference?

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Most of the workplaces that offer 403b will do so because the administrative costs are lower. However, it is impossible to open a 401k if your employer does not offer it. This implies that you don’t get to choose the plan you want. Instead, the employer chooses it for you. If you work at a hospital or any other governmental entity, you are eligible for this plan. If you work anywhere else, you will be eligible for the 401k plan. The 403b plan is cheaper to administer, which is why it is favored by small entities with tight budgets that want to offer workers a retirement plan.

Who Pays For the Investment?

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Since your employer sponsors your plan (either 401k or 403b), many people make an assumption they do not have to pay any fees. This is untrue as many 401k investors pay some of the highest fees out there. 401k allows an acceptable investment under the plan, but 403b only supports annuities and mutual funds.

Is There a Need To Understand 401k vs 403b?

You need to understand 401k vs 403b plans because you need to know which plan is best for you. Besides, both plans allow employers to offer menus of investment choices to workers. This will be handy upon retirement. You want to know the range of investment choices you have based on 401k vs 403b. You also need to know what features are needed in each plan based on the following parameters and features: 

  • Eligible employees
  • Eligible employers
  • Contribution limits of the employee
  • Contribution limits of the employer
  • Investment options for each plan
  • Testing involved
  • If filing form 5500 in annual tax reporting is required
  • Deductions and deferrals
  • Portability and rollover provisions of each plan
  • Vesting of each plan
  • Whether the plan is subject to ERISA
  • The facts of each plan
  • Loan provisions of each plan

Information On The Difference Between 401k vs 403b

401k vs 403b: Eligible Employees

403b supports all employees, but there are a few exceptions including:

  • Professors on sabbaticals
  • Employees who work less than 20 hours weekly
  • Certain students
  • Non-resident aliens with no U.S. income
  • Union employees covered under collective bargaining agreements

On the other hand, 401k plans are less restrictive but also have exceptions for individuals who exceed:

  • 21 years old 
  • 1000 hours of service annually
  • Completion of a one-year service

The plans may also exclude:

  • Non-resident aliens with no U.S. income
  • Union workers covered under collective bargaining agreements

401k vs 403b: Eligible Employers

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401k can be used by any employer, but 403b plans are restricted to educational organizations or nonprofit entities under IRC 501(c)(3).

401k vs 403b: Contribution Limits of The Employee

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Under 401k, employers are allowed to defer up to $18,500 annually, which is the set 2018 limit. Employer and employee contributions per worker should not exceed $55,000 unless the staff is aged over 50. If the employee is at least 50, they may defer up to an additional $6,000.

In the 403b plan, employees can defer up to $18,500 annually, which is the set 2018 limit. The contributions for both the employer and the employee cannot exceed $55,000. An exception is when the employee is aged 50 or more where an additional $6,000 is deferred. Besides, an employee of a qualified organization with 15 years of service may contribute an additional $3,000.

401k vs 403b: Contribution Limits of the Employer

In the 401k plan, the employer’s discretion is up to 25% of the eligible payroll. This can be made as a profit sharing or matching contribution. The contribution can also continue beyond 70.5. The 403b plan’s employer’s discretion is up to 25% of the eligible payroll. It can be made as an employer’s discretionary or matching contribution. The contributions may also exceed the age of 70.5.

401k vs 403b: Investments Option for Each Plan

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401k allows an acceptable investment under the plan, but 403b only supports annuities and mutual funds.

401k vs 403b: Testing Involved

401k plans are subject to ACP, ADP, and heavy testing. If an ERISA plan is used in 403b, then it is subject to ACP, ADP, and top heavy testing. The exception goes to state and local government employers and some churches.

401k vs 403b: Whether the Plan is Subject to ERISA

401k is subject to ERISA unless otherwise exempt (for example, in some governmental or church plans). For the 403b plan, it is subject to ERISA if considered an “employee benefit plan.” Employers often limit their role and do not provide employer contributions to the plan to be exempt from ERISA. There are certain ERISA rules that exempt 403b plans, for example, with governmental and certain church plans.

401k vs 403b: If Filing Form 5500 in Annual Tax Reporting is Required

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Under 401k, form 5500 annual reporting is required. There are special plans that cover spouses and owners. In 403b, if it is non-ERISA, no filing is required. For an ERISA plan, filing is mandatory.

401k vs 403b: Deductions and Deferrals

401k plans comprise employer contribution deductibles to the employer. In addition, the tax is deferred for employees. The contributions by the employee are pre-tax and tax-deferred. In 403b plans, employer contributions are tax-deferred for the employees. The contributions are also pre-tax and tax-deferred.

401k vs 403b: Portability and Rollover Provisions of Each Plan

Once you leave your employers, it is possible you can take your 401k with you. You are then eligible for a tax-free rollover either into the 401k plan of your new employer, a 457 plan, a traditional IRA, a 403b plan, or a SEP IRA plan. Besides, you can still rollover the 401k into a Roth IRA plan of a traditional retirement plan. In 403b plans, similar provisions are provided. However, only a 403b plan can be rolled to a 401k plan of the new employer.

401k vs 403b: Vesting of Each Plan

In 401k, there are several permissible vesting schedules. All worker elective deferrals are 100% vested immediately. This applies to 403b plans.

401k vs 403b: Loan Provisions of Each Plan

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One benefit of 401k is that an employee can take a loan against his account as long as the employer permits it. This implies that you can borrow up to 50% of the plan value, but a maximum of $50,000 is applied. You should repay the loan in 5 years. If the loan is taken to buy an employee’s principal residence, it can be repaid in over 5 years. The same applies to 403b plans.

Conclusion

Both plans allow employers to offer employees menus of investment choices, which are handy upon retirement. 401k plans are more common than 403b plans. Employers who set up 401k plans allow the employees to set aside a portion of their paychecks for retirement. 403b plans are less common than 401k plans. This is because Section 403b of the IRS, on which 403b plans are based, limits the eligibility of workers in tax-exempt organizations, such as religious groups, hospitals, and schools.

While in some respects one plan is better than the other, in most aspects they are the same. It’s just that 403b plans are meant for government and non-profit entities while 401k plans are meant for profit generating employers. That said, the plans are offered depending on the employer. Few employers offer both types of accounts. We hope that this article has highlighted the major differences between 401k and 403b so you know which plan you are eligible for.

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