403b vs 401k pros and cons

There are so many retirement saving plans, including the 403b and 401k. However, before putting your money into any saving plan, you should first understand how it works, its terms and conditions, and the difference between the 403b vs 401k. 

403(b) and 401(k) are both retirement saving plans suitable for different types of employees and offered by various employers. The plans are similar in several ways but only differ in some specific areas discussed in this article. 

These retirement plans are named according to the federal tax code that they fall under, and you can choose the amount you want to contribute in each of the payments you will make monthly. There are, however, some basic contribution limits set for each plan that you choose. 

What’s The Difference Between A 401k And A 403b?

difference between a 403b and a 401k

There are some differences between the 401(k) and 403(b) retirement saving plans, and apart from the difference in the employer type, where for-profit companies offer the 401(k) plan to the employees where the money is deducted directly from their payroll.

On the other hand, the 403(b) offers a retirement plan to employees of specific tax-exempt organizations; other differences include the following:

401(k) Plans 

complete 401k guide

401k is a savings retirement plan for employees in for-profit organizations, and the contributions are generally deducted from their earnings. 

Essentially, this is free money that you would otherwise pay as tax, but because of the plan’s advantages, you can choose the amount to contribute or to be deducted whenever you get paid. 

It is also entirely upon you to choose where to invest your money. This is because there are investment options that include stocks, bonds, annuities, ETFs, and mutual funds, among other investment areas. 

401k Match 

This is the money that some employers contribute towards your saving plan. Whenever you save a dollar in your 401(k) account, the employer can decide to match your contributions by a certain percentage. 

Therefore, as long as you continue contributing towards your 401(k) account regardless of your salary, your employer can add a certain proportion based on your annual contributions. It is also upon the employer to determine the matching contribution terms.

401(k) Contribution Limits 

If you are wondering how much to invest or put in your 401k account in 2022 and whether the limits are the same as that of the previous year or not, of course, it is a little more than the limits in the prior year. 

This is basically the limit you can contribute to your retirement plan if you are an employee of a qualified organization. The current limit for 2022 is up to $20,500, which is up by the $1000 contribution limits of 2021. 

403(b) Plans 

403b plans vs 401k plans

The 403b plan is also referred to as the tax-sheltered annuity plan. It is made for employees of tax-exempt institutions and government ministries where the money is deducted from their taxable income towards the saving plan. 

In this plan, as I mentioned earlier, you can only invest in two options that are; mutual funds and annuities. 

All the government employees, educational institutions, employees of religious organizations, public school systems organized by Native American tribal governments, cooperative hospital service organizations, and school employees, among others, are eligible plan participants and can contribute to this plan. 

Which Organizations Are Eligible For 403b Plans?

Plan 403b, as mentioned, is a retirement saving plan that covers employees from different nonprofit organizations and government employers. This includes: 

  • Employees from the public-school systems such as school administrators, teachers etc. 
  • Eligible employees from the churches or religious organizations. 
  • Employees from state colleges and universities. 
  • Eligible ministers from tax-exempt organizations and self-employed ones. 

403b Contribution Limits 

The 403b contribution limits, just like 401k, are $1000 up from the previous years’ limits. For example, the current limit for 2022 is $20,500. This is more compared to the 2021 annual contribution limit, which was $19,500. 

401k And 403b Withdrawal Rules 

It is important to note that, before withdrawals, you must attain a certain age or meet some other conditions. 

When you retire or are laid off from work early, specific rules apply. Therefore, before taking money out of your retirement plan, you need to know the rules to avoid early withdrawal penalties depending on which sector you are in. 

Under the rule, the employees are eligible to take out their money when they reach 59 ½ when they encounter financial hardship, die, become disabled, or have a severance from employment. These withdrawals that meet the conditions will not attract the 10% early withdrawal penalty and income tax. 

401k And 403b Advantages And Disadvantages 

Having a good retirement savings plan is always a good idea whether you are a government employee or a private sector employee. Every sector may have a plan for employees where they contribute to their retirement accounts. 

When choosing the right type of retirement plan that will work for you, you need to understand the advantages and disadvantages of the 401k and 403b. It also has its merits and demerits. 

In the 401k and 403b, there are common advantages that come with the plans and disadvantages. Some of the advantages of these plans include the following:

  • With the 403b plan, there are tax advantages to enjoy, and with 401k, employees’ taxable income is reduced. 
  • In the 401k and 403b, there are high contribution limits, higher for those above 50 years. 
  • There is an employer matching in the 401k and 403b, where an employer matches the contributions by specific proportions to your employee contributions. 
  • Extra catch-up contributions for older adults over the age of 50 years for the 401k and 403b retirement plans. 
  • Both investment type plans 401k and 403b have shorter vesting schedules. This is when you will be able to keep the funds that your employer matches to your account. 

Disadvantages Of 401k And 403b Retirement Plans 

Though these plans are beneficial, they also have some disadvantages regarding fees, penalties, and withdrawal. The disadvantages include the following:

  • In the 403(b) plan, there are only a few types of investment choices. This is where the 401k becomes more advantageous when it comes to investment options.
  • There are penalties for early withdrawals. If you make withdrawals before your retirement age, you are likely to pay a 10% penalty in both plans. 

Which Plan Should I Choose? 

When it comes to choosing a plan, you may not have such flexibility to choose the options of the 401k or 403b if you are an employee of either nonprofit or for-profit organizations. You can only choose one that your employer offers.

However, suppose you are self-employed, like in the case of church employees. In that case, you may be considered to belong to non-profit organizations, and that way, you will be eligible to contribute to the 403b retirement plan. 

You may also choose the best-qualified plan based on the investment options. For example, if you want to invest in stocks or bonds other than annuities and mutual funds as offered in the 403b plan, you may need to choose 401k to get more of such investment options.

Therefore, in the 401k, you have more flexibility regarding choosing investment options. 

Frequently Asked Questions (FAQs)

There are many questions surrounding these two retirement savings plans. Among the common questions that people commonly ask include the following: 

Can I Have A 403b And A 401k?

Yes, you can contribute to both plans to increase your retirement savings, but only if your employer offers both options. The type of plan to choose will depend on your employer-sponsored retirement plan. In addition, contributing to both plans also has a limit called the salary reduction contributions that you cannot exceed in one tax year. 

What Happens To Your 403b When You Quit?

If you quit paying to your contributions account, you will only lose the unpaid balance of the employer contributions if the period to keep is not yet realized. For the vested balance, you will keep them even when you quit. Therefore, you can choose to withdraw or transfer the same to a new employer with your vested balance. 

Final Thoughts 

I know it’s not a walk in the park to decide on which investment option to choose, especially when your employer offers both options, the 401k and the 403b retirement plans. But now, you know the differences and similarities, the advantages and disadvantages, the investment options each offers, and the type of employer that offers the plans.

With this information, you can now make an informed choice of your retirement savings plan. 

This content was originally published here.

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