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 Once the money is withdrawn, the investor will have to pay income taxes. If the money is withdrawn prior to the set period, which is after the investor turns 59.5 years of age, he/she will have to pay a penalty of 10%.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

Nondiscrimination Testing with 401k Plans

I want to set up a 401k plan for my auto parts shop. Do I need to ensure that it complies with the nondiscrimination regulations year after year? Michael P. Ladd, Oklahoma City, OK 

A 401k plan is a retirement benefit plan that was created with the intent of allowing employees to save in an effective manner for their future. The many benefits and tax advantages offered with these plans are all established in line with this objective. This is also the reason why the government insists that these plans are offered to all employees irrespective of their position within your business or the total compensation they earn.

To get all the tax benefits that a 401k plan offers to participants, it should give benefits to all employees, including the rank and file staff. A plan that only benefits the business owner or top level management fails to pass theIRS’s non discrimination test. This test compares the plan’s participation as well as contributions made by rank and file employees with those of top level employees and the owner/ management.

Annual testing is mandatory for all regular/ traditional 401k plans to verify that they are non discriminatory. Through this testing it is verified whether the contributions made on behalf of rank and file employees is in proportion with that made for the top brass of your business.

If you want to avoid getting into the testing and verification loop then aSafeHarbor401k is the right 401k plan for your business.SafeHarborplans are exempt from the annual non discrimination testing that is required for the other 401k types. This plan has some inbuilt features that ensures that all employees are given equitable treatment when it comes to contributions.

Talk to an investment advisor to know more about Safe Harbor 401ks and the advantages they offer for your business. If you will be using a DIY 401k package like http://401keasyonline.com/, you can browse through their website or ask their support staff for help on setting up and managing aSafeHarbor plan.