What are the Differences Between a 401(k) and a 403(b)?

While many people are familiar with the basic concept of the 401(k), not everyone knows or understands how a 403(b) functions. In many ways, the 403(b) plan resembles the 401(k) plan. Both are workable retirement plans, and each approach represents a viable component in responsible financial planning. However, there is one very significant difference to keep in mind.

Perhaps the single most important difference between a 401(k) and a 403(b) is who may qualify for each plan. In general, a 401(k) is a retirement plan option that is made available to persons who work for a business that is classified as a for-profit entity. Many corporations have gone to this type of program in order to allow employees the chance to assume greater responsibility in building a nest egg for later years. Because the contributions made by the employee are exempt from taxes, it is possible to reduce the amount of the annual tax obligation. While there are some limits on the amount that an employee can defer to a 401(k) annually, the structure of the program and the tax obligations surrounding the fund make it very attractive to make full use of the 401(k).

A 403(b) is also a retirement plan that allows an employee to make regular contributions to the fund throughout the year. However, unlike the 401(k), the 403(b) is open to persons who work with an entity that has been recognized as a non-profit organization. This means people who are employed with charitable organizations, schools, medical care facilities, and religious organizations can often enjoy the benefits of the program. Like the 401(k), the 403(b) does have some limitations regarding the amount of annual income that can be moved into the fund, as well as restrictions and penalties for early withdrawal.

It is important to note there is not any one 401(k) or 403(b) plan that is universally utilized by all employers. There are variations in the degree of matching contributions that employers will make to the fund, ranging from no matching funds to around half of the income placed into the plan by the employee. Also, some employers will only match half the funds up to a certain percentage of the employee’s annual salary.