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Key Takeaways
- A 401(k) plan is a type of retirement plan that provides employees with tax advantages while helping them save for retirement. This type of plan is an employer-provided defined contribution plan, governed by the Employee Retirement Income Security Act of 1974 (ERISA).
- A 403(b) plan is also a type of defined contribution plan, providing employees with tax advantages while helping them save for retirement. 403(b) plans are often called tax-sheltered annuity plans (TSAs), typically offered by public school, governmental, church, and non-profit employers, such as those who work for 501(c)(3) organizations.
- All 401(k) workplace retirement plans are governed by ERISA, where 403(b) plans may or may not be governed by ERISA.
- 401(k) and 403(b) plans have similar annual contribution limits. However, 403(b) plans offer two types of catch-up contributions, unlike only one offered by 401(k) plans.
- The Setting Every Community Up for Retirement Enhancement (SECURE) Act opened up additional possibilities for 401(k) plan sponsors to offer annuities similar to 403(b) plans.
Understanding the differences between workplace retirement plans can often seem daunting. This is especially true when you’re deciding which type of defined contribution retirement plan to offer. Defined contribution plans, like 401(k) and 403(b) plans, have numerous similarities. However, they also have key distinctions.
401(k) and 403(b) plans are both tax-favored workplace retirement plans sponsored by employers for their employees’ benefit. Yet, 401(k) and 403(b) plans are often offered to different organizations. For example, 401(k) plans are generally offered to employees of for-profit employers. On the other hand, 403(b) plans are generally offered to public school, governmental, church, and non-profit employees.
In this article, we explore the similarities and differences between 401(k) and 403(b) plans, including their availability, contributions, benefits, and limitations.
What Is a 401(k) Plan?
A 401(k) plan is a type of retirement plan that provides employees with tax advantages while helping them save for retirement.
The 401(k) plan is an employer-provided defined contribution plan, governed by the Employee Retirement Income Security Act of 1974 (ERISA). Unlike traditional pension plans, a defined contribution plan requires employees to contribute a fixed percentage of their salary, typically on a payroll-to-payroll basis. Additionally, an employer may provide additional contributions to the plan, such as matching or profit-sharing contributions.
Two types of 401(k) plans exist: traditional 401(k) plans and Roth 401(k) plans.
A Traditional 401(k) Plan
Let’s look at an example:
Say an employee makes USD 55,000 annually. If that employee contributes USD 7,000 to a traditional 401(k) plan on a pre-tax basis, then that employee’s annual salary is reduced by USD 7,000, resulting in a taxable income of USD 48,000. This employee would have income taxes withheld from the USD 48,000, not the USD 55,000.
A Roth 401(k) Plan
On the other hand, unlike a traditional 401(k) plan, employee contributions to a Roth 401(k) plan are made after income taxes are withheld from an employee’s paycheck. So, the employee does not enjoy a tax deduction in the year the contribution is made as they may with a traditional 401(k) plan.
Let’s look at the same example as above, except applying it to a Roth 401(k) plan. Say an employee makes USD 55,000 annually. If that employee contributes USD 7,000 to a Roth 401(k) plan on an after-tax basis, then that employee’s annual salary is not reduced. This employee would have income taxes withheld from the USD 55,000.
When the employee takes a withdrawal from their 401(k) plan, the employee does not pay taxes on the withdrawn contributions (and any investment earnings).
Employer contributions in 401(k) plans are typically subject to a vesting schedule, meaning that employees must stay with the company for a certain period of time before gaining ownership of their 401(k) employer contributions.
Employers may offer a 401(k) plan that offers both traditional pre-tax contributions in addition to Roth contributions, giving employees some flexibility when saving for retirement.
What Is a 403(b) Plan?
A 403(b) plan is also a type of defined contribution plan, providing employees with tax advantages while helping them save for retirement.
403(b) plans are often called tax-sheltered annuity plans (TSAs), typically offered by public school, governmental, church, and non-profit employers, such as those who work for 501(c)(3) organizations. Participants in 403(b) plans may include teachers, professors, school administrators, doctors, nurses, librarians, governmental workers, and clergy, among many more.
403(b) plans typically involve one of the following types:
- Plans that include commercially purchased annuities.
- Plans that include regulated mutual funds in custodial accounts.
- Plans that resemble traditional retirement income accounts; however, these can only be adopted by religious organizations and any related entities (such as a church-based hospital). These types of plans aren’t limited to annuities or mutual funds like the first two options.
Like a 401(k) plan, 403(b) plans permit employees to defer some of their paycheck to the plan, which is contributed on a pre-tax basis. However, 403(b) plans can also offer after-tax Roth contributions, which are currently taxed but distributed tax-free (including any earnings).
Employers may also make matching contributions to 403(b) plans, if they so choose.
Who Can Participate in a 403(b) Plan?
If eligible, the following employees may participate in a 403(b) plan:
- 501(c)(3) tax-exempt organizations employees, including certain ministers
- Public school system employees, including public schools, state colleges, and universities
- Church employees
- Indian tribal government public school system employees
- Certain self-employed ministers
Are 403(b) Plans Subject to ERISA?
This is a tricky question when it comes to 403(b) plans. Some are governed by ERISA and some are not.
If a 403(b) plan is subject to ERISA, then it must follow stricter requirements, such as ensuring that certain protections and rights are in place for plan participants and their families as well as filing specific governmental reports, such as Form 5500.
Here’s a snapshot of which employers may be subject to ERISA when sponsoring a 403(b) plan:
- Non-profit entities (such as 501(c)(30 entities) are often ERISA-covered but may qualify for non-ERISA coverage.
- Certain religious organizations are typically non-ERISA covered; however, church employers should note that this question is currently being litigated as to whether ERISA 403(b) plans can be offered by church-based hospitals.
- Certain governmental entities (including political subdivisions, governmental agencies, and instrumentalities) are always non-ERISA covered.
What Are the Contribution Limits for 401(k) and 403(b) Plans?
401(k) and 403(b) plans have similar annual contribution limits. However, 403(b) plans offer two types of catch-up contributions, unlike the only offered by 401(k) plans.
For 2024, employees can defer up to USD 23,000 of their compensation to their 401(k) or 403(b) plans. Employees aged 50 and older can contribute an additional USD 7,500 to their 401(k) or 403(b) plan, for a total of USD 30,500 annually. These contribution limits are typically adjusted annually for cost of living.
403(b) plans, however, have a second type of catch-up contribution not available to 401(k) plans. For 403(b) plans, a special 15-year catch-up is available. Employees with at least 15 years of service with their employer can make an additional annual contribution that is the lesser of:
- USD 3,000;
- USD 15,000, reduced by any elective annual deferrals made in previous years under this special catch-up contribution election; or
- USD 5,000 multiplied by the number of the employee’s years of service, minus the total elective deferrals made in previous years under this special catch-up contribution election.
For this special catch-up contributions for 403(b) plans, employees are limited to a maximum of an additional USD 15,000 in contributions.
Can 401(k) Plans Offer Annuities Like 403(b) Plans?
Traditionally, 401(k) plans have not offered annuities, like their 403(b) plan cousins. Instead, 401(k) contributions have been distributed in lump-sums as opposed to a lifetime income option, like an annuity.
However, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, opened up additional possibilities for 401(k) plan sponsors to offer annuities. For employers wishing to add annuities to their 401(k) workplace retirement plans, they must undertake a three-step process:
- Evaluate the inclusion of the annuity lifetime income option.
- Choose the annuity itself, if the employer determines that the inclusion of the annuity is reasonable and prudent.
- Choose an annuity provider.
For ERISA-governed plans, employers must document their process when determining whether annuities are appropriate, hiring and monitoring the annuity provider, and choosing the annuities to include in the plan.
Additionally, if the employee changes employers, the employees can transfer their annuity to an individual retirement arrangement or another employer-sponsored retirement plan, making the annuity portable and eliminating the need to liquidate the annuity by paying surrender charges.
Can Employees Contribute to Both a 401(k) and 403(b) Plan?
If employees have more than one job, and one employer offers a 401(k) plan and the other offers a 403(b) plan, then the employee may contribute to both plans, as long as they meet each plan’s eligibility requirements.
However, if an employee contributes to both plans, they are limited to the overall contribution limits. In other words, if an employee who is younger than 50 contributes to both a 401(k) and 403(b) plan in 2024, the employee cannot contribute more than USD 23,000 to both plans combined. If the employee contributes USD 10,000 to the 401(k), then they are limited to a USD 13,000 contribution to the 403(b) plan.
Conclusion
401(k) and 403(b) plans are similar in many ways. However, it’s essential to understand the differences, such as who can sponsor a plan and if your plan is subject to ERISA. This is not only critical when communicating the plans’ features, benefits, and limitations to your employees, but it’s also important when managing your plan compliantly.
Want to learn more about 401(k) and 403(b) plans? Talk to the employee benefits experts at Remote People.
Frequently Asked Questions
A 401(k) plan is a type of retirement plan that provides employees with tax advantages while helping them save for retirement. The 401(k) plan is an employer-provided defined contribution plan, governed by the Employee Retirement Income Security Act of 1974 (ERISA). Employees contribute to 401(k) plans at a fixed percentage of their salary, typically on a payroll-to-payroll basis. Additionally, an employer may provide additional contributions to the plan, such as matching or profit-sharing contributions.
Two types of 401(k) plans exist: traditional 401(k) plans and Roth 401(k) plans.
A 403(b) plan is a type of defined contribution plan, providing employees with tax advantages while helping them save for retirement.
403(b) plans are often called tax-sheltered annuity plans (TSAs), typically offered by public school, governmental, church, and non-profit employers, such as those who work for 501(c)(3) organizations. Participants in 403(b) plans may include teachers, professors, school administrators, doctors, nurses, librarians, governmental workers, and clergy, among many more.
Author: Jennifer Kiesewetter
Jennifer is an HR and employment compliance specialist with more than 20 years experience as a transactional attorney, focused on employee benefits, retirement plans and health plans.