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What's the Differences Between 401(k) and 403(b) Plans?

The main difference between 401(k) and 403(b) plans is that a 401(k) plan is typically offered by for-profit companies while a 403(b) plan is similar in structure but offered by non-profits or employees of public schools. Plans vary in how they work but their purpose is the same – to help employees build a retirement savings account.

401(k) Plan Details

A 401(k) plan is available to most companies, from large corporations to small businesses. Employers often match employee contributions by a matching percentage or a specific dollar amount. Any amount a participant contributes from their own paycheck is always vested. When account values are vested, they belong 100% to the participant and carry forward when or if they leave the company.

Example: if an employee contributes $6,000 annually and the employer matched 6% ($360), yearly contributions would equal $6,360. Any amounts that are not vested (on the employer’s behalf) remain with the employer when the employee leaves.

These plans are “qualified,” which means they must abide by the Employee Retirement Income Security Act (ERISA) rules. Employers must provide regular reports to participants about their accounts and cannot discriminate in favor of one employee over another. Employees must be eligible to participate in a plan no later than when they reach age 21 and have one year of service at the company.

Account values must be vested, or owned, according to one of two schedules as required by law:

  1. They can follow an up to three-year “cliff” approach and be 100% vested after three years (or sooner)

  2. They can follow a two to six-year “graded” approach (after two years 20% vested for the next five years, then 100% vested)

403(b) Plan Details

A 403(b) plan is offered by most public schools, religious organizations (such as churches, synagogues, mosques) and tax-exempt 501(c)(3) organizations. They also are known as tax-sheltered annuities (TSAs). Most 403(b) plans do not include employer matching contributions. This means all account contributions come 100% from employee contributions. Plans that do not include employer matching contributions are not subject to some ERISA rules (unlike plans that do include employer matching).

Non-ERISA plan accounts are always 100% vested because contributions are made only by employee contributions. ERISA plans must follow standard ERISA vesting schedules. Health, education and religious (HER) organization 403(b) plans can provide for special catch-up contributions after an employee has worked for the organization for 15 years, but other rules apply. A sub-set of 403(b) plans allows for mutual fund investments rather than using only annuities.

Contribution Limits

Both plans allow participants to contribute up to $19,500 in 2020. Participants over age 50 can contribute an additional $6,500 in 2020. Contributions are made through a pre-determined amount -- the participant’s salary is reduced by the amount she or he wants to contribute to the plan. Money in either account will grow on a tax-deferred basis and is not taxed until it is withdrawn.

Contribution Type 401(k) and 403(b) Maximum contribution amount $19,500 Maximum catch-up contributions (age 50 and older) $26,000

Plan Distributions

Plan participants can withdraw funds without penalty after they reach age 55 if they have left the employer. In some cases, money in the plan may be accessed prior to the established age limit due to a hardship. Hardship withdrawals require immediate and heavy financial need and have specific rules that must be followed. A participant may borrow up to 50% of the account value or $50,000, whichever is less. Although a plan is not required to provide loans or hardship withdrawals, it may be an option.

Participants may begin withdrawing account balances without penalty based on one of three criteria:

  1. Reaching age 55 and separating from service

  2. Reaching age 59½

  3. Having a disability

Beneficiaries also may withdraw funds without penalty. Specific rules may apply to any distribution plan, the plan administrator should be consulted for specific details.

Required Minimum Distributions (RMDs)

Participants must begin taking funds from the account by age 72 (2020 SECURE Act) unless they continue to work for the employer. The amount of each RMD can be determined using an appropriate chart from the IRS. The first RMD must be taken no later than April 1 of the year following the year in which participants reach age 72. Failure to withdraw the required amount results in a tax penalty of 50% on the amount that was not distributed.

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