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

Employer-sponsored retirement saving plans, such as 403(b)s and 401(k)s, can be important tools to help you save for retirement. But the type of plan you have access to depends on where you work. If you work in the private sector, you will likely have a 401(k), while government or certain nonprofit workers may have access to a 403(b). Although these two types of plans are similar in many ways, there are some important differences.

What is a 403(b)?
A 403(b), also known as a tax-sheltered annuity (TSA) plan, is a defined contribution retirement plan for employees of non-profit organizations, government workers and public school employees, such as professors, teachers, and school administrators.

A 403(b) lets workers set aside a portion of their paychecks in a retirement account before taxes are taken out. In addition, some employers contribute to their employees’ plans, often matching a portion of what employees set aside.

Workers can invest their contributions in mutual funds or annuities and reinvest returns on a tax-deferred basis, which can help their savings grow faster. Annuities are a product offered by insurance companies to help individuals set up a regular source of income. The products allow you to make a lump-sum payment or a series of payments, which then grow inside the product. At a later date, you receive regular payouts.

Annual individual contributions for a 403(b) are capped at $19,000 in 2019 and $19,500 in 2020. he combined contributions for both an employer and employee cannot exceed $56,000 a year in 2019 and $57,000 a year in 2020, or 100% of the employee’s most recent annual salary.

Employees with 15 years or more of service with a qualified organization may be eligible to contribute an additional $3,000 a year to their 403(b). Employees who are age 50 and older are eligible to make catch-up contributions of an additional $6,000 a year, or $6,500 in 2020.

Contributions to 403(b) plans and returns are tax-deferred. Individuals pay income tax when they make withdrawals from the accounts. You’ll need to wait until you are 59 ½ to withdraw funds penalty-free, otherwise you could be hit with early withdrawal penalties of 10% in addition to income tax.

When you reach age 70 ½ you must make required minimum distributions every year. The government determines how much you are required to withdraw based on account balance and your life expectancy.

What is a 401(k)?
Employers in the private sector may offer their employees a 401(k) retirement plan as part of their benefits package. Like 403(b) plans, 401(k)s are tax-deferred savings vehicles designed to help employees save for retirement.

Just like with a 403(b), employees with a 401(k) make pre-tax contributions directly from their paychecks. Neither employee contributions nor the earnings on investments are taxed until employees withdraw the funds when they retire, or after age 59 ½. Like 403(b)s, employers may make matching contributions to employee accounts.

401(k) plan contribution limits are the same as for 403(b) plans—$19,500 a year for individuals and $57,000 for combined employer/employee contributions in 2020, up from $19,000 a year for individuals and $56,000 in combined contributions in 2019. People age 50 and older are eligible to make catch-up contributions of an additional $6,500 a year in 2020, up $500 from the year before. As with a 403(b) plan, funds withdrawn from a 401(k) before age 59 ½ are subject to a 10% early withdrawal penalty.

When it comes to how you invest, 401(k) plans typically offer a limited set of investments to choose from, such as a handful of mutual funds, target-date funds and exchange-traded funds. Though rare, it’s possible that a 401(k) may also include annuities as part of its offerings.

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