Knowing the difference between a 401k and a 403b is crucial to your retirement planning.
With the average retiree having only $65,000 in savings, it’s no surprise that many people are perplexed by the differences between a 403(b) and 401k. A 403(b) plan is sponsored by your employer, whereas you or your employer typically sponsors a 401k plan.
The rules governing eligibility, contribution limits, and plan features can vary greatly depending on the type of account you have at work. But understanding what distinguishes these accounts will allow you to make more informed decisions about how to save for retirement, so let’s take a look at them.
What are 401k and 403b retirement plans?
A 401(k) and a 403(b) are both tax-advantaged savings accounts.
That is, you can save in these accounts without paying taxes on the money until it is withdrawn, which is usually during retirement when your income is likely to be lower than it is now. As a result, many people advocate using these accounts to save for retirement rather than investing outside of them.
The primary distinctions between a 401k and a 403(b) plan are the type of entity that sponsors it (you or your employer), the eligibility requirements, contribution limits, plan features, how you take distributions from the account after leaving employment with either company and the tax treatment.
What is a 403(b)? How does it differ from a 401k?
A 403(b) is an employer-sponsored retirement plan available to employees of most nonprofit organizations, schools, and religious institutions.
In general, you can contribute up to $18,500 per year if you are under 50 and $24,500 if you are 50 or older. Contributions are tax-deferred until retirement when they are taxed at your ordinary-income rate.
What is a 401k? How does it differ from a 403(b)?
A 401(k) plan is sponsored by either you or your employer.
You can generally contribute up to $18,000 if you’re under 50 and $24,000 if you’re 50 or older. You can usually make tax-deferred contributions (traditional 401k).
Still, your employer may also offer a Roth 401k option, which provides no immediate tax savings but allows you to pay taxes on the money in retirement when your income may be lower than it is now.
Contributions are limited by how much you earn each year or by rules governing “leapfrog” contributions, in which you contribute extra to catch up after being out of work for a while. Still, there is no limit to how much can go into these accounts over time as long as you follow the rules.
When it comes to your employer, you can roll over an old 401k or 403b account into a new one if they offer this service, but you will lose any tax benefits that came from opening these accounts in the first place if you do so. When you leave either company, the distribution requirements for each type of account are different.
Distributions from a 401k are taxed as ordinary income when taken. In contrast, distributions from a 403(b) can be either taxable or nontaxable depending on whether they are made before or after the age of 59½, as well as the type of contributions to your account.
Distributions from both types of accounts are considered income to determine whether or not you are eligible to contribute and how much you can contribute.
Why should I choose one over the other?
401k and 403(b) accounts both allow you to save for retirement tax-free, but they have different features that may make one more appealing than the other.
For example, if your income is greater than $18,000 (and you are under the age of 50), it is most likely preferable to contribute to a Roth 401k account.
If you have an old employer-sponsored retirement plan, you might want to consider rolling your funds into a new one so that the tax advantages of opening these accounts last as long as possible.
In addition to deciding which type of account is best for you, consider how much money and time it would take to manage your retirement account daily. If it takes too much time, you might want to consider hiring an investment professional or using Robo-advisor software to help you save for the future.
What are some other factors I should consider?
Other considerations include your employer’s matching contributions, account fees, and whether or not you have other accounts that are similar to a 401(k) or 403(b) (b).
If this is the case, roll over all of them at once rather than leaving money in various retirement plans. You should also avoid keeping too much cash in these accounts because it is preferable to have your money working for you rather than sitting in a low-return savings account.
Do I need help choosing which one is right for me?
You may be able to determine whether you should choose a 401k or 403(b) plan on your own, but numerous factors can complicate your decision. If you’re unsure, consult with a financial adviser to determine what’s best for your situation and long-term goals.
Most people opt for a 401(k) or 403(b), but it’s critical to understand the differences between the two so you can make an informed decision about which one is best for you.
Consider your income, current employer, and retirement account contributions and how much time it will take to manage the accounts daily to determine which type of plan is best for you.
Pros of a 401k include:
- Contributions are tax-deductible.
- Employer-sponsored funds
Cons of a 401k include:
- Limited investment options for some plans, especially those run by smaller companies, and fees on these accounts can be high. This is less likely with larger employers that offer more comprehensive retirement benefits.
Pros of a 403(b) include:
- Employer matching funds
- More investment options
Cons of a 403(b) include:
- Contributions are not tax-deductible; in some cases, early withdrawals may be subject to taxes and penalties. This is another reason it’s critical to consider how long you intend to work before retiring because if you don’t plan for withdrawals, your money could be locked up for decades.
- It’s worth noting that many 403(b) plans aren’t as generous with employer matching contributions.
How much does it cost to set up a 401k or 403b savings account?
In most cases, there is a fee to open either of these types of accounts.
Many employers, for example, offer low-cost plans with very low fees and other costs if you open an account with them rather than going directly to another financial institution.
To determine the total cost of opening and maintaining either type of account, compare the total amount that would be required each year.
It would be best if you also considered how much it would cost you to hire an investment professional or use Robo-advisor software to help you plan for your future without all of your efforts.
When do I start contributing money to my 401(K) or 403B account?
It’s best to start contributing as soon as possible, primarily if your employer provides matching funds. This is free money that you are essentially giving away since it will be returned to you later on in life when you retire.
What types of investments do I have for my 401(K) or 403B plan?
There are frequently many investment options available, such as various types of mutual funds and separate accounts.
If you’re not sure what these are, or if your current plan is limited in some way, consider consulting with a financial planner to help you determine the best path for your future retirement goals and needs.
How do I withdraw money from my 401(K) or 403B plan?
Early withdrawals are typically taxed, so you will likely want to aim not to withdraw funds until retirement.
There are also penalties if you withdraw money from a 401(k) before the age of 59½. To avoid penalties and taxes, make sure you understand all the rules for withdrawing funds from your account.
Which type of retirement account do I need?
A variety of factors determine this.
If you intend to retire early or if your employer offers matching funds, you should enroll in a 401(k) plan before doing anything else. However, each account type has numerous advantages and disadvantages that should be considered to make the best decision moving forward.
It also depends on how much money you need to save each month to meet your long-term retirement goals.
If you’re unsure, consult with an investment professional or learn more about the various types of accounts available before making any hasty decisions without all of the necessary information.
What are some other factors I should consider?
You will usually want to understand the full scope of how your money is invested and the fees associated with each account. It would also be ideal to consider whether you have a solid understanding of investing in general, as managing these accounts can be challenging at times.
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