You may be familiar with the terms 401(k) and 403(b) from reviewing your retirement plan options. However, it’s typical to feel overwhelmed when opening a retirement account. Many people don’t know all the minor details of each retirement plan.
What are the differences between these retirement plans, and how does legislation passed recently affect them? We’ll discuss those topics in this article.
401K vs 403b
This section will discuss the difference between 401k and 403b plans and how legislation passed recently affects them.
401(k) plans are privately owned businesses’ retirement plans. Contributions can be made post-tax or pre-tax from an employee’s salary. Employers who offer 401(k) plans can offer matching contributions to their employees up to a certain percentage and add profit-sharing features.
401(k) plan earnings accrue tax-deferred, so the employee doesn’t pay income taxes on the money until they withdraw it. Until then, because 401(k)s are tax-deferred retirement investments, it reduces their take-home pay which lowers their taxable income.
Employees begin to enjoy retirement income when they withdraw funds, known as “taking distributions.” Distributions are taxed at the same rate as salary.
The 401k SECURE Act builds on initiatives to help Americans achieve financial security. Changes to required minimum distributions (RMDs), automatic enrollment, and incentives for new plan start-ups are among its provisions.
With the SECURE Act, the minimum retirement distribution (RMD) age is raised from 72 to 75, with a phase-in option until 2033, so consumers can continue to save.
It also proposes a new catch-up contribution. Employees over 50 can contribute another $10,000 to their retirement accounts, and their contributions are indexed for inflation.
SECURE Act 2.0 addresses retirement savings and student loan debt for younger employees. Rather than contribute to a 401(k) or another type of retirement plan, employees can choose to pay off their student loans first. Employers could still match these contributions.
Some people choose to buy an immediate annuity as a lump sum payment before retiring. These require an upfront, one-time premium.
Deferred annuities build up over time. Premiums are paid over time, but you don’t start receiving benefits until you retire.
403(b) plans are retirement plans for certain employees of public schools, nonprofit organizations, and ministers.
Employees can choose from annuities or offer mutual funds for these plans. However, they must work for a tax-exempt organization to participate in it.
Under the MAC rule, an employee who has worked for their employer for at least 15 years can exceed the standard elective deferral limit on 403(b) plans.
This rule increases the maximum contribution by up to $3,000 a year over 402(g) limits, subject to certain limitations. There can be no more than one increase in elective deferral limits:
The Difference Between 401k and 403b Plans
There are a few differences between 401(k) and 403(b) plans.
Employees of private companies can contribute to 401(k) plans. Employees of tax-exempt organizations like public schools and certain churches can contribute to 403(b) plans.
403(b) plans only invest in mutual funds or annuities, but 401(k) plans have bonds, stocks, and annuities.
Both plans allow employer matches, but fewer employers match 403(b) plans.
Both plans offer the same contribution limits. The 2022 contribution limit is $20,500. A person over 50 years of age can contribute an additional $6,500 per year.
403(b) plans are less expensive because the government doesn’t want to burden non-profit organizations. Employers pay more for 401(k)s.
The tax advantages of these plans come from employees not having to pay taxes until they withdraw their contributions.
You cannot withdraw from a 401(k) or 403(b) account until you turn 59 ½ without incurring a penalty.
Single Employee Options
A single-member 401(k) plan covers a solo business owner or that person and their partner. They have the same rules and requirements. There are no 403(b) plans for single employees.
403(b) plans are exempt from nondiscrimination testing, but 401(k) plans are not.
403b vs 401k Similarities
403b vs 401k Differences
There are a few differences between 403(b) and 401(k) plans.
Although they offer employer contributions, fewer companies contribute to 403(b) retirement plans.
It is possible to have lower expense ratios if the 403(b) plan isn’t subject to ERISA since reporting requirements aren’t as stringent.
Investment options and cost
Fees and costs vary depending on your retirement plan’s investment options. 401 k plans may offer more variety through cheaper index funds and ETFs, whereas 403(b) plans might have expensive mutual funds and annuities as investment options.
Here are some commonly asked questions about 401k and 403b plans:
Can You Have Both a 401K and 403B?
Yes – if your employer offers both, you can contribute to both.
What Happens to Your 401k or 403b if You Quit?
When you quit your job, you have a few options for what you can do with your 401k or 403b. For example, you can withdraw it as cash, roll it into an IRA, or roll it over to a new employer’s 403(b) or 401(k).
Can You Lose Money With A 401k or 403b?
Contributions to a 403(b) can’t be taken away or forfeited. Employer contributions are subject to vesting requirements.
401(k) contributions can lose value since they are invested in various funds.
Does a 401k or 403b Affect Social Security?
401k or 403b distributions don’t affect Social Security.
The Bottom Line: Which Is Better?
Both 401(k) and 403(b) retirement plans have the potential to be powerful vehicles for saving, particularly if the employer contributes. Don’t forget, though, that all investing involves risk. But most employees can’t choose their plan. If you work for a private company, that company will offer a 401(k) plan. If you work for a public company, they’ll offer a 403(b) plan.
This content was originally published here.