401(k) vs. 403(b): What Is the Key Difference?

Retirement planning is a fundamental aspect of long-term financial well-being. Employer-sponsored retirement plans serve as powerful tools for accumulating savings, often providing tax advantages that can significantly boost growth over time. Understanding the various options available through employers is an important step in making informed decisions about personal financial security.

Understanding 401(k) Plans

A 401(k) plan is a defined contribution retirement plan primarily offered by private sector companies. Employees contribute a portion of their salary, often on a pre-tax basis, directly into the plan, which reduces their current taxable income. Some plans also allow after-tax Roth contributions, where earnings grow tax-free and qualified withdrawals in retirement are also tax-free. Employers frequently enhance these savings through matching contributions or profit-sharing allocations, which can significantly accelerate an employee’s retirement savings.

The Internal Revenue Service (IRS) sets annual limits on contributions to 401(k) plans. For 2024, an employee can contribute up to $23,000 in elective deferrals. Individuals aged 50 and over are permitted to make an additional “catch-up” contribution of $7,500, bringing their total employee contribution limit to $30,500 for the year. The total amount contributed to an employee’s account from all sources, including employee deferrals, employer matching contributions, and profit-sharing, generally cannot exceed $69,000 for 2024, or $76,500 if including age 50 and over catch-up contributions.

Investment options within 401(k) plans typically include a range of mutual funds, exchange-traded funds (ETFs), and sometimes target-date funds, offering diversification across various asset classes. Employer contributions, such as matching funds, are usually subject to a vesting schedule, meaning an employee must work for the company for a certain period before fully owning these contributions. Rules for withdrawals are generally strict before age 59½, often incurring penalties, though provisions exist for loans against the vested balance or hardship withdrawals under specific circumstances. Upon leaving an employer, funds can typically be rolled over into another qualified retirement plan or an Individual Retirement Account (IRA).

Understanding 403(b) Plans

A 403(b) plan is a defined contribution retirement plan specifically designed for employees of public schools, certain tax-exempt organizations, hospitals, and religious institutions. Like 401(k)s, these plans allow pre-tax or Roth contributions, reducing taxable income or providing tax-free withdrawals in retirement. Employers may also make matching or non-elective contributions, boosting savings.

The contribution limits for 403(b) plans are generally aligned with those of 401(k)s. A unique feature of some 403(b) plans is the “15-year rule” catch-up contribution. Employees with at least 15 years of service with the same eligible employer may be able to contribute an additional $3,000 per year, up to a lifetime maximum of $15,000, provided their average annual contributions have been less than $5,000. This special provision allows long-term employees to significantly increase their savings.

Investment options often include annuities and mutual funds, with annuities being a historically common choice due to their guaranteed income streams. Like 401(k)s, 403(b) plans have specific rules for vesting employer contributions, as well as for loans, hardship withdrawals, and rollovers upon employment termination.

Key Distinctions

The primary distinction between 401(k) and 403(b) plans lies in the type of employer that offers them. For-profit companies typically sponsor 401(k) plans, serving employees in the private sector. In contrast, 403(b) plans are exclusively available to employees of public schools, certain non-profit organizations, and religious institutions. This fundamental difference shapes many of the regulatory and operational aspects of each plan type.

Investment options also vary between the two plan types. While 401(k) plans generally offer a broader array of investment vehicles, including various mutual funds and exchange-traded funds, 403(b) plans have historically featured annuities prominently alongside mutual funds. The availability and diversity of investment choices can influence a participant’s ability to tailor their portfolio to their risk tolerance and financial goals. Participants in 403(b) plans might encounter a more limited selection of investment providers compared to 401(k) plans.

Nondiscrimination testing requirements represent another significant divergence. Most 401(k) plans are subject to stringent annual Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, designed to ensure that contributions do not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). If these tests fail, corrective actions, such as refunding excess contributions to HCEs, may be required. For 403(b) plans, employee elective deferrals are generally exempt from ADP testing due to “universal availability” rules, which mandate that all eligible employees must be offered the opportunity to contribute. However, employer contributions to 403(b) plans are still subject to certain nondiscrimination rules, including ACP testing, though governmental and church plans often have fewer or different requirements.

Contribution rules, while generally similar in their standard and age 50 catch-up limits, include a notable difference in the 15-year rule unique to some 403(b) plans. This special catch-up allows long-term employees in eligible organizations to contribute an additional $3,000 annually, up to a lifetime maximum, beyond the standard limits. This provision is not available to 401(k) participants. Loan and hardship withdrawal rules are largely similar for both plan types, though specific plan documents dictate the exact terms and availability of these features.

Plan administration and oversight also differ, particularly regarding the Employee Retirement Income Security Act (ERISA). Most 401(k) plans are subject to ERISA, which imposes comprehensive federal requirements for fiduciary duties, reporting, disclosure, and participant protections. Many 403(b) plans, especially those sponsored by governmental entities or churches, are exempt from ERISA, leading to potentially less stringent administrative and fiduciary oversight. However, non-ERISA 403(b) plans still must adhere to IRS regulations.