You can save for retirement in a 401(k) plan or a 403(b) plan, depending on which type of account your employer offers. Both retirement accounts offer similar tax benefits, but there are also some important differences between a 401(k) plan and a 403(b) plan.
A 401(k) and a 403(b) both:
— Have a contribution limit of $20,500 in 2022.
— Allow catch-up contributions of up to $6,500 at age 50 or older.
— Provide tax breaks to employees who save for retirement.
— Might provide employer matching contributions.
What Is a 401(k)?
A 401(k) is a tax-advantaged employer-sponsored retirement savings plan provided through private sector companies. Many 401(k) plans include an employer match. For example, a company may provide 50 cents per dollar saved for the first 6% of pay contributed by the worker.
[Read: How Much Should You Contribute to a 401(k)?]
What Is a 403(b)?
A 403(b) is also a tax-advantaged employer-sponsored retirement plan that covers nonprofit and tax-exempt organizations and institutions. Participants covered by these plans include teachers, university professors, government employees, doctors and hospital employees and nonprofit organization employees. “A hospital or a school will have a 403(b),” says Scott Staton, president of Staton Financial Group in Oklahoma City, Oklahoma. “It’s just a different section of the tax code that pertains to different types of employers.”
Can You Save in a 401(k) and a 403(b)?
Employees generally don’t have a choice between a 401(k) or a 403(b). You are typically offered one type of employer retirement account through your job. “Most people just have one option based on where they work,” Staton says. However, if you happen to have access to both plans, you can contribute to multiple types of employer based retirement accounts in the same year, but your contributions to these plans combined cannot exceed the annual deferral limit, which is $20,500 in 2022, or $27,000 at age 50 or older.
[Read: New 401(k) Contribution Limits for 2022.]
Similarities Between 401(k)s and 403(b)s
Both a 401(k) and a 403(b) allow you to defer paying income tax on your retirement savings. “The tax treatment is the exact same,” Staton says. “It’s all tax deferred, and then it’s taxed as ordinary income when you take withdrawals and subject to required distributions at 72.” You may also be eligible for a Roth 401(k) or Roth 403(b) that allows you to contribute after-tax dollars and then take tax-free distributions in retirement, if your employer offers that option.
These types of retirement accounts typically have a 10% tax penalty for early withdrawals taken before age 59 1/2. Also, a 401(k) and a 403(b) allow for loans, hardship withdrawals and catch-up contributions for employees age 50 and over.
A 401(k) and 403(b) both might provide employer contributions, but it is up to the individual employer whether to match employee retirement savings.
[See: 9 Ways to Avoid the 401(k) Early Withdrawal Penalty and Other Fees.]
Differences Between 401(k)s and 403(b)s
While 401(k)s and 403(b)s offer similar tax benefits, there are some important distinctions between the two accounts.
If you participate in a 403(b) and have over 15 years of service with certain nonprofits or government agencies, you may be able to make additional catch-up contributions to a 403(b) plan. Contributions can be increased up to $3,000 per year, with a lifetime limit of $15,000. Those with 401(k) plans can’t make these special catch-up contributions.
While both 401(k)s and 403(b)s have a limited selection of investment options, 401(k)s tend to have more investment choices. “If you’re looking at 403(b)s, they are limited in scope of assets,” says Sam Zimmerman, CEO and co-founder of Sagewell Financial in Cambridge, Massachusetts. “For a while, it was really annuities only. They have since expanded to include mutual funds. It’s more restrictive with the 403(b).”
[Read: How to Max Out Your 401(k) in 2022.]
In contrast, 401(k) plans are allowed to offer a wider range of investment products. “When I do a left-right comparison, 403(b)s are usually annuity heavy and then they have lots of mutual funds. Pretty much it’s either mutual funds or annuities,” says Morgan Hill, CEO of Hill & Hill Financial in Woodstock, Georgia. “With a 401(k) there’s usually a huge array of different options and choices for people to select.”
Most people don’t get a choice between a 401(k) and a 403(b), but if you do, some financial advisors recommend selecting a 401(k) to get access to more investment options. “I would usually recommend a 401(k),” Zimmerman says. “You can invest in more different asset classes, which is almost always a positive.”
More from U.S. News
12 Ways to Avoid the IRA Early Withdrawal Penalty
How to Reduce Your Tax Bill by Saving for Retirement
10 Tax Breaks for People Over 50
A 401(k) Versus a 403(b) for Retirement Savings originally appeared on usnews.com
