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

When you start a new job, there’s a decent chance you’ll have an employer-sponsored retirement plan available to help you save for the future in a tax-advantaged way. Two of the most popular types of accounts are the 403(b) and the 401(k). These two accounts are similar in several ways, but also have some key differences.

Keep reading to learn how the two types of plans work, their similarities and differences, and which one is better for you.

A 403(b) plan, also known as a tax-sheltered annuity or TSA plan, is an employer-sponsored retirement plan available to certain public and nonprofit employees. These accounts are usually offered by public schools and tax-exempt organizations.

Using a 403(b) plan, employees can defer some of their salaries into an investment account pre-tax. It lowers the employee’s taxable income in the year they make the contribution, and then the money grows until the employee reaches age 59½, at which point they can withdraw funds from the plan as a source of retirement income.

A 401(k) plan is another employer-sponsored retirement plan that allows workers to invest for retirement in a tax-advantaged way. But unlike 403(b) plans, which are available to employees of public schools and tax-exempt organizations, 401(k) plans are usually only available to private-sector employees. According to the National Compensation Survey, about 56% of companies offer a 401(k) plan conducted by the U.S. Bureau of Labor Statistics.

Both the 403(b) and 401(k) are designed to help American workers save for retirement. These plans have a few key differences, but also have plenty of similarities.

403(b) and 401(k) plans are identical when it comes to the tax perks they offer. A standard 403(b) or 401(k) plan allows workers to contribute to their account with pre-tax income, meaning that the funds are taken from their paycheck before taxes have been withdrawn. The employee’s investments can grow tax-free while they’re in the account, and the account holder will pay taxes on their distributions during retirement. These contributions have the tax benefit of lowering someone’s taxable income in the year they make a contribution—and therefore reducing the amount of income taxes they’ll owe.

Both 403(b) and 401(k) plans also have the option of Roth contributions. When you contribute to a Roth account, you do so with after-tax money, meaning the money doesn’t reduce your gross income or tax liability in the current year. However, the funds grow tax-free in your account, and you can withdraw them tax-free during retirement.

Whether you choose the pre-tax or post-tax account, you’ll also have the benefit of tax-deferred retirement investments. As long as the money remains in the account, you won’t pay capital gains and income taxes as the money grows.

403(b) and 401(k) plans have the same contribution limits. In 2022, the Internal Revenue Service allows workers to contribute up to $20,500 to a 401(k) or 403(b) plan; in 2021 the limit was $19,500. Both plans also allow for additional catch-up contributions of $6,500 per year for workers ages 50 and older.

It’s important to note that workers can contribute a combined $20,500 to their employer-sponsored retirement account. If you have access to more than one type of plan, you can only contribute a combined total of $20,500 across all plans.

Both 403(b) and 401(k) plans allow employers to contribute to their employees’ retirement accounts. Employers can offer either a flat contribution amount or a percentage of the employee’s salary. For both accounts, employers are limited to contributing up to 25% of someone’s payroll.

When you become vested in a plan, you have ownership of the plan dollars. Both 403(b) and 401(k) plans can require a vesting schedule, where employees gain ownership of their employer matching contributions over a number of years.

For both types of retirement accounts, employees are immediately 100% vested in their own contributions. Vesting for employer contributions may happen over a longer period of time.

The withdrawal rules for 403(b) and 401(k) plans are very similar. Both plans are designed for retirement savings, meaning the Internal Revenue Service prefers that you not withdraw money from the account in your younger years.

In general, you must be 59½ to take distributions from your 403(b) or 401(k) plan. If you withdraw money earlier, not only will you pay the income taxes due on the funds, but you’ll also pay a 10% penalty.

There are some exceptions that may allow you to withdraw funds from your retirement account early, including if you’re disabled or have suffered a financial hardship. Both types of plans also allow participants to take out loans from their accounts, but they’ll have to pay the funds back with interest.

There are plenty of similarities between 401(k) and 403(b) plans, but there are also some key differences.

One of the most important differences between a 403(b) plan and a 401(k) plan is who is eligible to contribute. As we mentioned previously, only certain public-sector and nonprofit employees can participate in a 403(b) plan. Those eligible include nonprofit employees, public school employees, government employees, and church employees. A 401(k) plan, on the other hand, can be offered by for-profit companies to its employees.

Keep in mind that within each plan, there could be certain eligibility requirements. For example, a plan may be available only to full-time employees but not part-time employees. Other plans may require that someone work for a company or organization for a certain amount of time before they’re eligible to participate.

403(b) plans and 401(k) plans also differ in the types of investments available. For 401(k) plans, there are few limitations on what someone can invest in. When the employer sets up the plan, they’ll choose a menu of investments that will be made available to employees. This menu often includes stocks, bonds, mutual funds, ETFs, annuities, and more.

403(b) plan participants have fewer options when it comes to their plan investments. The Internal Revenue Service limits 403(b) plan funds to be invested in annuities and mutual funds.

The Employee Retirement Income Security Act (ERISA) regulates 401(k)s and 403(b)s. However, 403(b) plans do not have to comply with many of the regulations that govern 401(k)s. For instance, 403(b) plans do not have to comply with the nondiscrimination testing. Nondiscrimination testing is designed to stop companies from giving a disproportionate amount of benefits to management and highly compensated workers.

The only reason 403(b) can sidestep ERISA regulations like nondiscrimination testing is that 403(b) plans are not technically categorized as employer-sponsored as long as only the employees make contributions. If an employer does start to make contributions to an employee’s 403(b) account, they would automatically become subject to the same ERISA guidelines and reporting requirements that 401(k) plans have to abide by.

One feature that applies only to 401(k) plans is the ability to provide profit-sharing contributions to employees. While employers aren’t required to pass any of their profits along to employees, they can choose to do so through retirement contributions. 403(b) plans can also offer employer matches to workers but it rarely happens because it means losing the ERISA exemption that 403(b) plans enjoy.

As you can tell, 403(b) and 401(k) plans are very similar. The most significant difference between the two comes down to what types of employers offer them. Because of that, you probably won’t have a choice between a 403(b) or a 401(k) plan. Nonprofit and public school employees can participate in a 403(b) plan, while employees of for-profit companies will probably have access to a 401(k) option.

In general, you can’t withdraw money from your 403(b) plan to buy a home without paying taxes and penalties on the distribution.

Technically you can have both a 403(b) and a 401(k). However, many employers only offer one or the other. Additionally, you can only contribute up to a combined limit of $20,500, so having both accounts doesn’t double the amount you can save.

When you leave a job, you can choose to keep the money in the current plan, roll it over to your new retirement account, or take a distribution (though you’ll be subject to taxes and penalties).

The 401(k) annual contribution limit is the same for everyone, regardless of their salary. If your salary is equal to the contribution limit, then yes, you can contribute 100% to your retirement plan. However, you cannot contribute more than your salary. So if you earn less than $20,500, you can only contribute up to 100% of your income to your 401(k).