401(k) vs. 403(b): Which Retirement Plan Is Better?

Employer-sponsored retirement plans are important for long-term financial security. Understanding 401(k) and 403(b) plans is key for making informed decisions about retirement savings. This article clarifies the characteristics of each plan and highlights considerations for choosing between them.

Understanding 401(k) Plans

A 401(k) plan is a retirement savings vehicle offered by for-profit companies. Employees can contribute a portion of their pre-tax salary or after-tax as Roth contributions. Contributions grow tax-deferred, and qualified Roth withdrawals are tax-free in retirement. Employers often provide matching contributions, which may be subject to a vesting schedule. Vesting determines when an employee gains full ownership of employer contributions; employee contributions are always immediately 100% vested. Common vesting schedules include “cliff vesting,” where full ownership is granted after a period, or “graded vesting,” where ownership increases incrementally.

The Internal Revenue Service (IRS) sets annual contribution limits for employee deferrals. For 2025, the employee contribution limit is $23,500, with an additional catch-up contribution of $7,500 for those aged 50 and over. A new catch-up contribution of $11,250 applies for those aged 60-63, if the plan allows.

Accessing funds before age 59½ incurs a 10% early withdrawal penalty from the IRS, plus ordinary income taxes. Exceptions exist for permanent disability, certain medical expenses, or separation from service at age 55 or older. Some plans allow participants to borrow against their vested balance, generally up to 50% or $50,000, whichever is less, with a repayment period of five years, or longer for a primary residence. Investment options within 401(k) plans are determined by the employer and commonly include mutual funds, exchange-traded funds, and target-date funds.

Understanding 403(b) Plans

A 403(b) plan is a retirement savings arrangement primarily for employees of public schools, colleges, universities, and tax-exempt organizations, including hospitals and charities. Like 401(k)s, these plans allow pre-tax or Roth contributions, with earnings growing tax-deferred. Many employers offer matching contributions, often subject to vesting schedules.

The IRS sets annual contribution limits for 403(b) plans. For 2025, the elective deferral limit is $23,500, with an age 50 and over catch-up contribution of $7,500. A higher catch-up contribution of $11,250 is available for those aged 60-63, if the plan allows. A unique feature is a special 15-year catch-up contribution, allowing long-term employees with at least 15 years of service to contribute an additional amount, subject to specific cumulative and annual limits.

Withdrawals before age 59½ incur a 10% IRS penalty, plus ordinary income tax. Exceptions exist for death, disability, or separation from service at age 55 or later. Some 403(b) plans permit participants to take loans from their vested account balance, typically up to the lesser of 50% of the vested balance or $50,000, with a repayment period limited to five years, or longer for a primary residence. Investment options commonly include annuities and mutual funds.

Key Distinctions and Commonalities

The primary distinction between 401(k) and 403(b) plans lies in the type of employer. 401(k)s are provided by for-profit private sector companies, while 403(b)s are offered by non-profit organizations, including educational institutions, hospitals, charities, and certain governmental entities. This difference dictates their regulatory framework.

Regarding investment options, 401(k) plans often feature a broader array of mutual funds and exchange-traded funds. In contrast, 403(b) plans historically emphasized annuity contracts, though mutual funds are now common. The unique 15-year catch-up contribution provision available in some 403(b) plans for long-serving employees is not present in 401(k)s.

Many aspects of 401(k) and 403(b) plans are similar. These include pre-tax or Roth contributions, tax-deferred growth, and shared standard employee contribution limits (including age 50 and over, and age 60-63 catch-up provisions). Both typically include employer matching contributions subject to similar vesting schedules. Rules for loans and early withdrawals, including the 10% IRS penalty for distributions before age 59½, are also largely consistent.

Factors for Choosing a Plan

When considering an employer-sponsored retirement plan, several factors warrant evaluation, regardless of whether it is a 401(k) or a 403(b). The availability and generosity of employer matching contributions are paramount, as this represents essentially “free money” that boosts savings. Understanding the specific vesting schedule for these employer contributions is important, as it dictates when those funds become fully owned by the employee.

The range and quality of investment options within the specific plan should be examined. This includes assessing the diversity of available funds, their historical performance, and particularly their expense ratios. Lower expense ratios mean more of the investment returns remain in the account, compounding over time. Additionally, individuals should consider any plan-specific fees that may reduce overall returns.

Beyond plan features, personal financial goals and risk tolerance play a role. Evaluating whether the plan offers a Roth contribution option can be significant for tax planning, depending on an individual’s current and projected future tax bracket. While the core mechanics of 401(k)s and 403(b)s are similar, the specific design and offerings of each employer’s plan can vary considerably, making a thorough review of the plan’s summary plan description and investment options important for an informed decision.