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By Transamerica / Jul 28, 2015

What Is the Difference Between a 401(k) and 403(b)?

15-5535 TA BLOG IMAGE 401(k) 403(b)

By now, the term 401(k) might be familiar to you, particularly if your employer offers a 401(k) plan and encourages you and your fellow employees to start saving for your retirement. But what if your employer offers a 403(b) retirement plan? You might ask yourself what is a 403(b), and is it similar to a 401(k)?

How are 401(k) plans and 403(b) plans similar?

A 401(k) and 403(b) serve the same purpose. Both are tax-deferred retirement plans in which you can contribute up to $18,000 for the calendar year. Most plan administrators will cap you to avoid going over the limit. If you do over-contribute, which can happen if you switch jobs and have a retirement plan with both employers, you have until April 15th of the following year to withdraw anything over the limit, including any investment gains. That combined amount is added to your taxable income for the year.

Both plans have early withdrawal penalties. Early withdrawal penalties occur when you withdraw funds from your retirement account before you turn 59 1/2 years old. The penalties are a 10% tax on the amount that you withdraw.

How are 401(k) plans and 403(b) plans different?

Private and public for-profit companies offer the 401(k), while only nonprofit organizations, school districts, and religious groups can offer the 403(b) retirement plan. It is far less common, but in some cases, nonprofit organizations also may choose to offer 401(k) plans. The investment choices in each type of plan also differ. 403(b) plans are restricted to annuity contracts, mutual funds and money market funds, whereas 401(k) plans can include publicly traded securities.

Is there a difference in how one contributes to the plans?

You contribute to a 403(b) the same way you contribute to a 401(k), which is by investing a percentage (or dollar amount) of each paycheck you receive to the retirement plan. In some cases, an employer may also match an employee’s 401(k) contributions up to a certain percentage.

Is there a difference in how an employer matches employee contributions?

Some nonprofit organizations that offer 403(b) plans may not match employee contributions, but if they choose to do so, the matches work the same whether you have a 403(b) or 401(k) retirement plan. Employer matches and your commitment to consistently save (experts recommend striving for at least 10% of your income) can make either the 401(k) or 403(b) a perfect plan for your retirement. Just keep in mind that because both a 401(k) and 403(b) are tax-advantaged, if you begin saving approximately $100 each month from age 26 until you retire at 66, you will have $443,000. Over the lifetime of the plan, the value of your contributions and your employer’s matches to your retirement fund benefit from compound interest. Compound interest occurs when the interest that your funds accrue begins to accrue interest of its own. In the same example, if your money was not in a tax-advantaged account, the value would only be $240,000.*

What separates a 401(k) retirement plan from a 403(b) is mainly the type of employer who administers the plan. So regardless of whether your employer offers a 401(k) or a 403(b), take quick advantage of either plan to help build your retirement fund.

Information in this article is general and is not intended as legal or tax advice. Retirement plans are complex, and the federal and state laws or regulations on which they are based vary for each type of plan and are subject to change. In addition, some products, investment vehicles, and services may not be available or appropriate in all workplace savings plans. 

*Illustration provided by Motley Fool. It is hypothetical and not meant to reflect the return of any specific investment.

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