403(B) vs. 401(K): What’s the Difference?

Q. Hi,I’m Carla, and I work as an IT consultant at a private firm. I was recently researching options for retirement funding and came across various options. Two options that really got my attention were the 401 (K) and the 403 (B). Which one do you think is the smarter option and what is the difference between the two?

Hi Carla! It’s nice to hear from you. Your question isn’t exactly common, but it’s a very valid one. We understand that things might seem a little confusing, but the differences between a 403(B) and a 401(K) are quite vast.

However, to make things easier for you to understand, we’ll begin by explaining the similarities. To begin with, both savings plans are named according to their respective section numbers in the IRS tax code.

Secondly, they’re both tax-deferred retirement plans aimed at helping citizens save up money. As a result, both plans permit employees to make pre-tax salary deferrals. As of 2014, you’re allowed to make tax deferrals of up to $17,550.

If you’re 50 or older, you can even make total contributions of up to $23,000 as your “catch-up” investment. These contribution limits vary according to changes in inflation rates.Basically, both plans allow employees to contribute a portion of their income to these respective investment plans before their pay is taxed. The plan itself is managed by a brokerage firm, which is also responsible for overseeing contributions.

The investments then grow by collecting interest until the investor (employee) wishes to withdraw the money. Once the money is withdrawn, the investor will have to pay income taxes. If the money is withdrawn prior to the set period, which is after the investor turns 59.5 years of age, he/she will have to pay a penalty of 10%.

Both these plans are highly beneficial for those who invest in them. Firstly, they are taxed less and secondly; the investment grows without taxation.

However, that’s where the similarities end and the differences begin. To start with, the 403(B) investment plan can only be offered by non-profits. This includes religious groups, governmental organizations, and school districts. This also means that certain administrative processes don’t apply to 403(B) plans, which brings down administrative costs. As a result, smaller organizations with minuscule budgets can offer this savings plan to their employees.
However, employers who offer 403(B) plans do not match the contributions made by employers, which is the case with a 401(K) plan. Plus, since 403(B) is typically offered by non-profits, there is no profit-sharing either.

Also, 403(B)s are limited to annuity contracts or custodial accounts invested in mutual funds, while 401(K)s can exist in the form of mutual funds, annuity contracts, and individually managed portfolios.

Now, to answer your question of which one’s better, it ultimately boils down to what kind of employer you’re working for and your own individual contributions. However, 401(K) manages to edge past due to the fact that employers match your contribution. More importantly, we’re willing to bet that your own employer offers only a 401(K) plan based on the assumption that it’s a private for-profit organization.