401(k) plans and 403(b) plans are two of the most popular employer-sponsored retirement plans available. The two have many similarities, including their contribution limits and tax advantages. However, they also have some key differences, including who can use them.

What is a 401(k) plan?

A 401(k) plan is an employer-sponsored retirement plan offered by many for-profit companies. The 401(k) that exists today was created in the Revenue Act of 1978 based on an idea created by Ted Benna, a retirement benefit consultant often touted as the “father of the 401(k).”

Read more: What is a 401(k)?

What is a 403(b) plan?

A 403(b) plan is an employer-sponsored retirement plan that’s very similar to a 401(k) plan. The key difference is that 403(b) plans are offered by public schools, churches, and 501(c)(3) non-profit organizations. The 403(b) plan was originally created in 1958, but it’s been expanded and adapted since then.

Similarities between a 401(k) and 403(b)

401(k) plans have a lot in common relating to their tax advantages, contribution limits, and other features. They share important advantages and disadvantages.

Tax advantages

401(k) plans and 403(b) plans are tax-advantaged, meaning workers can preserve more of their investment growth for retirement rather than losing some to taxes each year.

Most 401(k) and 403(b) plans are pre-tax accounts, meaning the money contributed is generally withdrawn from employees’ paychecks before taxes. This helps those workers to pay less in taxes that year. The money then grows tax-deferred in the account, and employees don’t pay income taxes on the money until they withdraw it during retirement.

Many 401(k) and 403(b) plans also accept Roth contributions. Rather than being made pre-tax, Roth contributions are made after an employee has already paid taxes on their income. Then, all investment growth in the account and distributions from the account are tax-free.

Employer match

For both 401(k) and 403(b) plans, employers may contribute to their employees’ plans in addition to the employee contributions. These are often done in the form of matching contributions. For example, a company might promise to match each worker’s retirement contributions up to 5% of their wages.

Contribution limits

Both 401(k) and 403(b) plans are subject to contribution limits. First, in both cases, employees can contribute up to $22,500 of their income to their workplace retirement plan in 2023, and $23,000 in 2024. Additionally, workers ages 50 and older may contribute an additional $7,500.

Early withdrawal penalties

Both 401(k) and 403(b) plans are intended to be used for retirement savings. As a result, both plans penalize workers who withdraw from their accounts before age 59 ½. For both accounts, any distributions taken before age 59 ½ that don’t qualify for any exceptions will be subject to a 10% tax penalty. That’s in addition to the ordinary income taxes you’ll pay on non-Roth retirement withdrawals.

Required minimum distributions (RMDs)

Pre-tax retirement accounts, such as 401k plans, 403b plans and IRAs, are subject to Required Minimum Distributions (RMDs). These withdrawals allow the IRS to collect tax on assets that have not yet been taxed.

Retirement account owners must take their first required minimum distribution for the year in which they reach age 72 (73 if they reach age 72 after Dec. 31, 2022). The withdrawal amount required is based on the account balance at the end of the previous year, along with the average life expectancy for a person of that age. The withdrawals are typically taxed at the individual's ordinary income rate. 

If a person fails to take the required minimum distribution within a given year, the amount not withdrawn is subject to a 25% excise tax. But there is the possibility to reduce that penalty to 10% if the RMD is taken within two years.

What is the difference between 401(k) and 403(b) accounts?

Just as they have some important similarities, 401(k) and 403(b) plans also have some key differences.

Availability

Perhaps the most important difference between 401(k) plans and 403(b) plans is who is allowed to use them. As mentioned, 401(k) plans are provided by for-profit companies. If you work in a corporate job, you likely have access to a 401(k) plan.

403(b) plans, on the other hand, are available to employees of public schools, churches, and organizations classified as tax-exempt under IRC 501(c)(3).

You might have access to a 403(b) if you are one of the following:

• An employee of a 501(c)(3) organization
• An employee of a public school system involved in the day-to-day operations of a school
• An employee of a cooperative hospital services organization
• A civilian faculty member of the Uniformed Services University of the Health Services
• An employee of a public school system organized by an Indian tribal government
• A minister that meets one of the following criteria:
  • You’re employed by a 501(c)(3) organization
  • You’re self-employed
  • You’re employed by an organization that’s not a 501(c)(3), but you function as a minister in your day-to-day professional

Investment choices

401(k) plans often have a wide variety of investment options. Most plans allow employees to invest in a variety of mutual fund or exchange-traded fund (ETF) options. Many also allow employees to invest in individual stocks and bonds, as well as other investments.

403(b) plans have a far more limited number of investment options. Per federal law, 403(b) accounts can only invest in annuities and mutual funds.

Additional contributions

We’ve talked about the contribution limits on 401(k) and 403(b) plans, as well as the catch-up contributions for employees 50 and older. But 403(b) plans also have another catch-up contribution option.

If you’re an employee of a 403(b) and have worked there for at least 15 years, you can make a catch-up contribution each year that’s the lesser of:

• $3,000
• $15,000 minus any additional elective deferrals made in previous years
• $5,000 times your years of service minus your total elective deferrals made in previous years

If an employee of a 403(b) is 50 years or older and has at least 15 years of service, they may take advantage of both catch-up contributions.

401(k) vs. 403(b): Which plan should I choose?

In most cases, you won’t have a choice between a 401(k) plan and a 403(b) plan. After all, they are offered by different types of employers. However, some workers may have multiple employers and, therefore, access to multiple retirement plans. If you have access to both a 401(k) and a 403(b) or are trying to choose between jobs with different retirement plans, here are some things to consider:

• Investment options: First, consider the investment options available in each retirement plan. 403(b) plans have relatively limited investment options. If you have access to a 401(k) plan with more robust offerings, you may want to go that route.
• Employer matching: Both 401(k) and 403(b) plans can offer employer matching, but that doesn’t mean they all do. An employer match is a part of your total compensation package and equates to a 100% return on your investment; don’t pass it up.
• Roth availability: If you want to make Roth contributions to your retirement account to get tax-free withdrawals, make sure to check whether your 401(k) and 403(b) offer a Roth option. Both plans can offer Roth options, but not all plans do.

If you have both a 401(k) plan and a 403(b), you may contribute to both. However, you may only contribute up to the individual contribution limit of $22,500 in 2023 and $23,000 in 2024 (plus any catch-up contributions you’re eligible for). And when you have multiple accounts, you’re limited to the total contribution amount across all your accounts.

Making the most of your retirement investments

No matter what type of retirement plan you have through your employer, there are steps you can take to maximize it. After all, the retirement contributions you make from the start of your career will have a major impact on whether you can retire comfortably.

First, experts generally recommend investing 15% of your income in your retirement account each year. If it’s not possible to contribute 15%, start at a lower percentage and gradually increase it over time. At the very least, contribute at least enough to take advantage of any employer match you have.

Next, remember to focus on other areas of your financial health. Paying off your debt and building an emergency fund can help provide for a secure retirement, just like investing can. First, being debt-free and having an emergency fund can help reduce your living expenses during retirement. They can also ensure you don’t have to pull money from your retirement account early to cover any financial emergencies that arise.

Choosing the right investments for your retirement plan

Regardless of whether you have a 401(k) or a 403(b), you may have the option to choose your own investments. There’s not necessarily one option that’s best for everyone.

Many employers offer target-date funds, which are mutual funds that automatically rebalance with a lower risk level as you near the target date (aka your retirement year). These funds have the benefit of simplicity. If you choose to opt for something other than a target-date fund, make sure to prioritize building a diversified portfolio that fits your time horizon and risk tolerance.

The role of retirement planning

If you’re early in your career, it’s possible you may not yet be prioritizing retirement planning. After all, retirement is decades away, and there are many competing goals for your paychecks. However, taking charge of your financial future now can help you reach your financial goals — not just your retirement goals — and live more comfortably during your later years.

One reason retirement planning is so important is the unique financial burdens faced by older Americans; one study found that more than 23% of Americans age 66 and older live in poverty, which is one of the highest rates for developed nations.¹

Another consideration for retirement planning is that, for most people, retirement isn’t an age but a dollar amount. People may assume they’ll retire at age 62 or 65. But that’s only possible by building up savings. On the other side of the same coin, by saving aggressively during your working years, you may be able to retire even earlier than you anticipated.

If you don’t have a retirement plan in place, now is the time to create one.

Read more: Seven essential steps for retirement planning