You’ve probably heard of both of these terms, but do you really know the difference between a 403b vs 401k?
Even though in the My Money Deisgn household we have both types of plans, to be honest there was a long stretch of time where I didn’t know what the major differences and similarities were between the 403b or 401k.
So like most things financially, I jotted down some questions and began looking into each one to find out the answers. Below are my notes on what I found out:
The 403b vs 401k – How Are the Same?
What are these plans?
Both are U.S. tax advantaged savings plans intended to help people save for retirement. Although each is only available through your employer, read below for the differences.
What do they do?
These plans allow you to divert money from your paycheck free of income taxes to be placed in a special investment account. That money is then invested and allowed to grow tax-deferred until you decide to withdraw it.
What does that do for me?
A lot! Since both plans allow you to use your money before taxes, this results in more money saved than if you would have made similar investments after taxes. Additionally, the fact that the money grows tax-deferred also gives it much greater potential for growth than if you had to pay regular taxes each year in a common brokerage account.
How much can I put in?
When can I get access to my money?
Both accounts let you withdraw your money a number of ways:
• You reach age 59 ½
• Separate from employment (and retire) in the year turning age 55
• Apply for Substantially Equal Periodic Payments (SEPP)
• Becomes disabled as per section 72(m)(7) of the Internal Revenue Code
• Through a loan (if allowed by the investment company)
What if I Take It Out Anyways?
The IRS charges a mandatory 10% penalty in addition to ordinary income taxes on the amount withdrawn.
Can I just keep my money in the 403b or 401k forever?
No. The IRS has Required Minimum Distributions (RMDs) for both plans starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. That means that you are required to take out a certain minimum percentage each year (and pay taxes on it).
How are a 403b and 401k Different?
Who can contribute?
The 401k is generally used for private sector employees. The 403b is used for public education organizations, hospital service organizations, and self-employed ministers, and some non-profit employers
Which one was created first?
Although you hear about the 401k more lately, you may be surprised to learn that the 403b was established first in 1958. It was designed to encourage employees in certain tax-exempt organizations to establish retirement savings programs.
The 401k was not created until 1978. Throughout the 1980’s and 90’s as pension plans started to become phased out, the 401k plan gained tremendous popularity.
What does each plan invest in?
One of the characteristics of the differences between a 403b and 401k is their offering of investment choices. Generally the 401k plan has more flexibility than the 403b. 401k plans usually offer mutual funds, stocks, ETF’s, etc. The 403b is usually an annuity contract offered through an insurance company, but as of recently mutual funds have become a choice as well.
Is the vesting rate the same?
Typically it takes longer to become fully vested in a 401k than it does a 403b because each private company has the ability to create whatever vesting rules they choose to use.
Readers – Which of these plans do you have? One , both, none? What differences have you noticed between a 403b vs 401k?
Image Credit: MMD