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 Once the money is withdrawn, the investor will have to pay income taxes. If the money is withdrawn prior to the set period, which is after the investor turns 59.5 years of age, he/she will have to pay a penalty of 10%.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.

What are the things you need to know before taking out a 401(k) loan?

Q. I am currently in a tight financial situation. The company I have worked in for over ten years offers a 401(k) plan to its employees. I was thinking of taking out some amount from my 401(k) account as a loan. However, I have heard that this may not always be the best option. I wanted to know more about how a 401(k) loan works, and any other thing that will be of help. Scott, Wisconsin

Hi Scott, while you may be tempted to take out a 401(k) loan, it is true that it may not always be the best option since failure to repay will have serious consequences. Consider it your last resort if you have no other options. Many people think that since you are borrowing your own money, it is a simple process. But the truth is that taking out a 401(k) loan is not as simple as it sounds.

If you still think that borrowing from your 401(k) plan is the way to go, then there are some things to keep in mind. The first thing you have to check is how much you can borrow. Usually, the limit is set to 50 percent of your retirement plan or $50,000 – whichever is the lesser amount.

When borrowing from your 401(k) plan, you don’t have to go through a credit check since you are taking out your own money; no financial institution is loaning you the money.

However, even though you do not have to run a credit check, you still have to pay the interest. The interest rate depends upon your loan plan, which is usually based on the current industry rates. Apart from this, taking out a 401(k) loan will also require you to follow a strict repayment schedule. This means that you have to pay back your loan, along with interest, within five years. However, if you use the loan to buy a home, the period for repayment is usually more than ten years.

Lastly, make sure that you do not miss any of your payments. Failure to repay your 401(k) loan on time will have some serious repercussions. If you miss a payment, your employer will regard it as you withdrawing from your 401(k) plan. This means that not only will you have to pay taxes on the loan you take out but also pay the penalty for withdrawing from your retirement plan early.

Has the government increased the contribution limit for 401(k) in 2018?

Q. Hi, I recently heard about an increase in the 401(k) contribution limit and would like to know about the possibilities regarding the same. I am about to max out my 401(k) contributions and also looking for ideas on how to save better this year. My current employer offers a 401(k) retirement savings plan. Christopher, North Carolina.

A. Yes, it is true. An increase in the 401(k) contribution limit has been announced by the government after its annual reassessment. This means that almost 80 percent of the workforce that counts on its 401(k) accounts as a key source of income after retirement can expect benefits.

In 2018, the 401(k) contribution limits will be increased by $500 to reach $18,500. 401(k) is an excellent option for retirement savings since the money continues to grow without being taxed, even though there is a restriction on the amount you can withdraw each year.

Today, a 401(k) plan is the most popular retirement savings scheme offered by an employer to the workers. And now, with an increase in the contribution limit, you can expect bigger savings opportunity and greater security for your post-retirement life.

The optional deferral limit was kept constant by the IRS in 2017. However, this year, it has chosen to increase the limit so that it is par with the continuously rising living costs. While there has been an increase in the contribution limit for 401(k), it is important to note that the catch-up limit for contribution remains the same in 2018 i.e. $6,000 on a total of $24,500. This is the limit that permits people who are 50 years or more to make higher contributions.

It will be vital for payroll and HR managers to make adjustments to their systems and to communicate about the new contribution limits to their employees in annual enrollment materials. The increase in the 401(k) contribution is the only one that has happened since the 2015 plan year and indicates a 1.97 rise in the consumer price index (2016-17 third quarter comparison).

You need to note that the limits are only applicable to optional 401(k) deferrals. This means that they are the contribution limits which one chooses to withhold from their paycheck in order to make contributions their account. In the given scenario, it might be a good idea for high earners to make slightly higher contributions as it will help them reach their maximum annual limit.

 

What are the latest Trends in 401(k) plans with respect to small businesses and data security?

  1. I have been reading a lot about the retirement saving issues in the U.S. lately. And it seems that the 401(k) is the primary solution for tackling this problem. I run a small business in a rented office space in California. I wish to know whether I need to offer 401(k) plans to my employees. Also, what are the data security risks that need to be considered with regards to 401(k)? Brian, California

Hi Brian, yes it’s true that there is a renewed emphasis on the 401(k) plans and they are being viewed as the primary solution to the retirement savings in the United States.

With increased awareness of the crisis around retirement savings, several states in the country are now waking up to take powerful measures. The steps to make retirement simpler and largely automatic has led to an increased possibility of individuals participating in the 401(k) plans being offered by their employers.

You will find that numerous states have taken the initiative to create legislation which requires all businesses (except very small ventures) to offer as well as register their employees in a 401(k) plan. Some of the states that are actively working on this legislation include California, Illinois, New York, Oregon, Massachusetts, Virginia and Minnesota.

The aim of creating such legislation is to allow bankruptcy experts to withdraw the retirement plan assets of employees from the insolvent firm in a quick and efficient manner.

There has been a lot of publicity of the data breaches faced by the Republican and Democratic parties in the country. All this publicity has greatly raised the concern for data security, even for retirement plans such as 401(k). It is true that retirement savings plans are also subject to hacking risks and savvy companies are making consistent efforts to protect the critical information in their employees’ 401(k) accounts.

There was a recent article published by Jackson Lewis that highlighted existing legislation as well as the security measures that employers can take in the future in order to protect sensitive data.

Some of them include the following:

  • Implementing due diligence for all information and security measures while choosing and supervising vendors.
  • Offering training to personnel on various legal and fiduciary responsibilities.
  • Creating privacy contingencies for contracts developed with service providers.
  • Providing restricted access to all sensitive data to personnel.
  • Creating written rules, policies and processes that have details about the federal laws and applicable state for personnel.

You can consult 401keasy for a quick and easy setting-up of your 401(k) account.

Can I withdraw money from my 401(k) account?

Q: I have been employed by this corporate for nearly four years now. I’m 36 years old and trying to collect funds for my son’s private school tuition fee. The fee is quite high and it is rather difficult for me to manage it within my fixed monthly salary. Also, I am the independent earner in the family. Can I withdraw funds from my 401(k) plan? What are the long-term consequences of this action? Alice, Colorado

Ans: Alice, the answer to your question is-Yes. You can definitely withdraw a part of or all of your contributions from your 401(k) account. But each withdrawal is subject to taxes. Therefore, it isn’t as simple to withdraw earnings and collections from your 401(k) account and any potential penalties or taxes due will primarily depend on your age.

Finance experts suggest that even though you could borrow money from your 401 (k) account, you should do so with a lot of reservations. This is because besides your home, your employer-funded retirement plan likely constitutes the majority of your total wealth.

It is important to understand that once the savings in your 401(k) plan are withdrawn, it is very hard to replace them. 401(k) is a tax-advantaged account and therefore allows the accumulation of pretax contributions, with no taxes hindering that growth. The huge advantage of maintaining a 401(k) account is that new earnings get generated on the old ones and you can thus accumulate a greater amount of money as compared to a regular taxable account.

Although you might feel tempted to withdraw money from your 401(k) account, you will end up losing this rather lucrative savings opportunity. This is especially true for younger investors. If you withdraw money from your 401(k) account before the age of 55 years, you will likely face high penalties.

If financial hardship is making you consider a withdrawal from your 401(k) savings, then you could think about a 401(k) loan. However, avoid taxable withdrawals as much as possible.

Broadly speaking, there are only three scenarios in which you should consider pulling out money from your 401(k) account:

  • When the average account balance has reached a $92,500 high.
  • You are equipped to handle repayments.
  • If you quit employment, the loan might become due.

Most investment experts would advise against withdrawal from a 401(k) account and let the account ride for as long as possible. Also, do your research when looking for a credible provider. For instance, www.401keasy.com can help you easily set up an account, make contributions and also track all account activities within minutes.

What happens to 401K if the employer goes bankrupt and the company shuts down?

Q: I have been working at this company for about five years now and I have a 401K plan through them. I have been hearing that the company has been making losses for quite some time now and that they are on the verge of bankruptcy. If they do shut down, do I lose my 401K savings? Should I withdraw all the funds right now, to play safe? Please advise- Stephen, Dallas.

Ans.: Stephen, there is no need to panic and there is absolutely no need to withdraw your money from the 401K plan. In fact, I recommend that you DO NOT do this because you stand to lose the range of benefits that come from investing in this plan which comes with a clear tax benefit.

The 401K account that employees like you have is not held by the company itself. The company’s management or accounts personnel have no access to your money in this account either. In case of a company facing a bankruptcy, there is no way for anyone, except, the account holder, that is, you, in this case, to utilise the money in the 401K or divert it in any way.

Now what happens if the company does shut down? Well, the 401K plans will most likely be terminated. That does not mean your money is gone. All you may have to do, if this happens, is to roll over the savings that you have accumulated in this account to another one. The smart move here is to roll the cash over into another retirement savings account that offers tax benefits. An IRA is a good option for you because it lets you avoid paying taxes on the sum and you can also avoid the premature withdrawal penalty by simply switching over to a traditional IRA. Also, you do want to continue saving for your future, right? The IRA gives you the perfect opportunity to continue doing so.

What you should be doing right now to safeguard your interests and avoid anxiety is keep track of your 401K. Get your HR department to give you information about the 401K account so that you can create a login and access it online at your leisure. Also do some groundwork about other retirement savings plans that you may be able to opt for, in case this one is closed down because of company closure. If your plan is held with providers like www.401keasy.com, this should not be a problem at all because the focus here is on user friendly interface, customer service and ease of use!

Getting the most out of your 401k plan

I am 24 and I will be starting my first job early next month. I want to invest wisely right from the beginning and want to know all about the 401k plan. Will I be eligible for applying to my company’s 401k plan? What should I ask my employer about it? – Karen Shawn

Hi Karen,

It is not often that I get questions about 401k from someone your age, simply because a lot of people do not think about retirement until they hit 40 or more, in spite of financial experts urging people to start planning retirement early. I must say that I am pleased to hear someone as young as 24 ask questions about the 401k, which is primarily an investment for retirement. Getting to your question about eligibility, the requirements for investing in the 401k plan are usually 1 or 2 years of service, and an appropriate age, which is 21 in this case.

As you mentioned you are 24, you meet the age criteria for the 401k. However, most employers need the employee to have at least 1 or 2 years of service to be eligible for the contribution plan. Some may have less restrictive eligibility criteria for their employees – the minimum age can be less than 21 and the number of years of service can be less than 1 year. So here is what you should ask your employer about the 401k.

  1. Will your employer match your contributions? This is the first thing you should ask your employer. The amount that your employer is willing to match can significantly increase your retirement savings. Usually, employers match your contribution, but the maximum they can contribute is limited to the plan they choose and the IRS policies.
  1. What will your investment options be? Your 401k will be invested into a variety of investment vehicles including stocks, mutual funds, GICs and bonds. You can continue with the plan offered by your employer or transfer some of the investment (partial rollover) to another plan if you do not like the investment options. We recommend that you visit 401keasy.com to learn about the different investment options you have.
  1. When will you become a vested employee? – The vested part of your 401k investment will be yours for good. Even if you leave your job, the amount that goes into your 401k will remain yours. Note that the contribution from your employer will vary based on their vesting requirements.

Can you withdraw your money, and when? If you need the money before retirement, due to an emergency or a problem, then you may be able to withdraw the money from your 401k investment. Find out under what situations you will be allowed to withdraw money from your 401k account and how much penalty you should pay, if any.