403(b) vs. 401(k): What’s the Difference?

If you’re saving for retirement through your employer, you may have heard of both 401(k) and 403(b) plans. At first glance, they can seem almost identical: both allow employees to contribute money from their paychecks toward retirement, often provide tax advantages, and may include employer matching contributions.

So, what’s the difference between a 403(b) and a 401(k)?

The biggest difference is who can offer the plan. A 401(k) is generally offered by private-sector employers, while a 403(b) is primarily available to employees of public schools, certain nonprofits, churches, and other qualifying tax-exempt organizations.

For many employees, the practical differences between the two plans are relatively small. However, contribution rules, investment options, employer contributions, and special catch-up provisions can vary.

What Is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan commonly offered by private-sector companies. Employees can generally contribute a portion of their paycheck to the plan, and employers may contribute additional money through matching or other contributions.

Traditional 401(k) contributions are generally made on a pre-tax basis. This means contributions can reduce your taxable income for the year, while withdrawals in retirement are generally subject to income tax.

Many employers also offer a Roth 401(k) option. With a Roth 401(k), contributions are made with after-tax dollars, but qualified withdrawals in retirement can generally be tax-free.

A 401(k) may offer a wide range of investments, such as mutual funds, target-date funds, and other investment choices selected by the employer's plan.

What Is a 403(b)?

A 403(b) is a tax-advantaged retirement plan designed primarily for employees of certain public schools, nonprofits, churches, and other eligible tax-exempt organizations.

Like a 401(k), a 403(b) can allow employees to make traditional pre-tax contributions or, when available, Roth contributions.

For example, a teacher working for a public school district may have access to a 403(b), while an employee at a private corporation might have access to a 401(k).

403(b) plans can use investment products such as mutual funds and annuities. The specific investment choices depend on the employer's plan.

One of the most important similarities is that 401(k) and 403(b) plans generally share the same annual employee contribution limits.

The IRS adjusts retirement-plan contribution limits periodically for inflation. Because these limits can change from year to year, it's important to check the current limits when planning your contributions.

Employees who are age 50 or older may also qualify for additional catch-up contributions.

Some 403(b) participants may have another potential advantage: the 15-year rule. Certain employees who have worked for the same eligible organization for at least 15 years may qualify for additional contributions under special rules, subject to specific requirements and limitations.

Employer Matching Contributions

An employer match can make a significant difference in retirement savings.

For example, suppose your employer offers a dollar-for-dollar match on the first 4% of your salary that you contribute. If you earn $60,000 per year and contribute at least 4%, the employer could contribute another $2,400 annually, assuming you meet the plan's requirements.

Both 401(k) and 403(b) plans can offer employer matching contributions.

If your employer offers a match, understand the matching formula and any vesting requirements. Vesting determines how much of the employer's contributions you are entitled to keep if you leave the company or organization.

Investment Options

Investment choices can vary considerably from one plan to another.

A 401(k) might offer a selection of low-cost index funds, target-date funds, actively managed mutual funds, or other investments.

A 403(b) may also offer mutual funds, but some plans have historically offered annuity contracts as well.

Rather than choosing between a 401(k) and 403(b) based solely on the plan name, review:

• The investment choices available
• Expense ratios and other investment costs
• Administrative fees
• Employer matching contributions
• Vesting rules
• Roth availability
• The quality and convenience of the plan's investment platform

A lower-cost plan with good investment choices can potentially be more attractive than a plan with higher fees, regardless of whether it's called a 401(k) or 403(b).

Traditional 401(k) and 403(b) vs. Roth

Both types of plans may offer two basic tax approaches.

Traditional

With a traditional 401(k) or 403(b), contributions are generally made before federal income taxes. Your investments can grow tax-deferred, and withdrawals are generally taxed as ordinary income.

Roth

With a Roth 401(k) or Roth 403(b), contributions are made after taxes. Qualified withdrawals can generally be tax-free, provided applicable requirements are satisfied.

Which option is better depends on your circumstances.

If you expect your tax rate to be higher in retirement than it is today, Roth contributions may be attractive. If you expect your tax rate to be lower later—or you value the tax deduction today—traditional contributions may make more sense.

Some investors choose to use both approaches to create tax diversification in retirement.

Withdrawal Rules

Both 401(k) and 403(b) plans are intended primarily for retirement, so taking money out early can result in income taxes and potentially an additional tax penalty.

There are exceptions to the early-withdrawal rules, and the details can differ depending on the circumstances and the plan.

For example, certain distributions may qualify for exceptions based on factors such as age, disability, qualified expenses, or other circumstances.

Because early withdrawals can have significant tax consequences, it's generally wise to understand the applicable rules before taking money out of a retirement account.

Required Minimum Distributions

Traditional retirement accounts generally aren't designed to hold tax-deferred money indefinitely.

At a certain age, federal law generally requires individuals to begin taking required minimum distributions (RMDs) from applicable retirement accounts.

The rules surrounding RMDs have changed in recent years, including changes to the ages at which RMDs begin. Roth accounts also have different treatment under current law.

Because RMD rules can be complex and may change, retirees should verify the current rules when planning withdrawals.

Which Is Better: 403(b) or 401(k)?

There isn't a universal winner.

For most people, the better plan is the one that offers the strongest combination of:

1. Low fees
2. Good investment options
3. A generous employer match
4. Reasonable plan features
5. Convenient payroll contributions
6. Tax options that fit your financial strategy

If you're a teacher, nonprofit employee, or other worker eligible for a 403(b), don't assume it's inferior to a 401(k). Likewise, having access to a 401(k) doesn't automatically mean you've got the better retirement plan.

The actual plan's fees, investments, employer contributions, and rules matter much more than the name.

Can You Have Both a 401(k) and a 403(b)?

Some people may have access to both types of plans—for example, if they work multiple jobs or change employers.

However, contribution limits can apply across plans. In particular, employee elective-deferral limits generally apply to the combined contributions you make to 401(k), 403(b), and certain other employer-sponsored plans during the same year.

This means you shouldn't automatically assume that having two accounts gives you two separate annual employee contribution limits.

There are special rules and exceptions, so anyone contributing to multiple workplace retirement plans should check the applicable IRS rules and their plan documents.

This article is for educational purposes only and is not individualized financial, tax, or investment advice. Retirement-plan rules and contribution limits can change, so consult current IRS guidance and your plan documents or a qualified professional for advice specific to your situation.