Is a 401(k) Better Than a 403(b) Retirement Plan?

Retirement planning is important for long-term financial security. Among retirement savings options, 401(k) and 403(b) plans are widely used. Understanding each plan’s characteristics is essential for informed decisions. This article aims to clarify the differences and similarities between these two common employer-sponsored retirement vehicles.

Defining 401(k) and 403(b) Plans

A 401(k) plan is a defined contribution retirement account primarily offered by for-profit companies to their employees. These plans allow individuals to contribute a portion of their pre-tax or after-tax (Roth) salary, with the investments growing tax-deferred until retirement. The contributions and earnings within a traditional 401(k) are taxed only upon withdrawal, typically during retirement.

A 403(b) plan serves a similar purpose but is specifically available to employees of certain tax-exempt organizations, such as public schools, universities, hospitals, and religious ministries. Like 401(k)s, 403(b) plans are tax-advantaged. They also permit contributions on a pre-tax or Roth basis, with tax-deferred growth. The fundamental distinction between the two lies in the type of employer that sponsors the plan.

Contribution Rules and Limits

Both 401(k) and 403(b) plans share similar contribution limits set by the Internal Revenue Service (IRS), which are adjusted annually for inflation. For 2024, employees could contribute up to $23,000 to either plan through elective deferrals. This limit increased to $23,500 for 2025.

Individuals aged 50 and over are eligible to make additional “catch-up” contributions. For both 2024 and 2025, this catch-up contribution amount is $7,500, allowing those aged 50 and older to contribute a total of $30,500 in 2024 and $31,000 in 2025. A new “super” catch-up contribution applies for participants aged 60, 61, 62, and 63, allowing an additional $11,250 in 2025 if the plan permits.

Employer contributions also play a significant role in both plan types, though they vary by employer. For 401(k)s, employer contributions can include matching contributions, where the employer matches a percentage of the employee’s deferral, or profit-sharing contributions, which are discretionary. While 403(b) plans can also offer employer contributions, they may be less common or structured differently compared to 401(k)s.

The total amount contributed to an individual’s account from all sources—employee deferrals, catch-up contributions, and employer contributions—is also subject to an overall limit. This overall defined contribution limit is $69,000 for 2024 and increased to $70,000 for 2025.

Investment Options and Distribution Rules

The types of investments available within 401(k) and 403(b) plans typically differ based on the plan’s design and the nature of the sponsoring organization. 401(k) plans generally provide a broader array of investment choices, frequently including a diverse selection of mutual funds, exchange-traded funds (ETFs), and sometimes individual stocks and bonds. This wider selection offers participants more flexibility in constructing a portfolio aligned with their risk tolerance and financial goals.

Conversely, 403(b) plans historically offered a more limited selection, often emphasizing annuity contracts, though mutual funds have become increasingly common. While annuities can provide a guaranteed income stream in retirement, they may also carry higher fees and potentially limit investment flexibility.

Both plan types share similar rules regarding distributions. Withdrawals made before age 59½ are generally subject to a 10% early withdrawal penalty, in addition to ordinary income taxes on the withdrawn amount. However, certain exceptions exist for this penalty, such as disability, qualified medical expenses, or separation from service at or after age 55, under the “Rule of 55.”

Required Minimum Distributions (RMDs) mandate that account holders begin withdrawing funds from their traditional 401(k) and 403(b) accounts at a certain age. Under the SECURE Act 2.0, the age for beginning RMDs increased to 73 in 2023, with a further increase to age 75 taking effect in 2033. Roth 401(k) and Roth 403(b) accounts are generally exempt from pre-death RMDs for the original account owner.

Participants in both 401(k) and 403(b) plans may be able to take loans from their accounts, if permitted by the plan. The maximum loan amount is typically the lesser of 50% of the vested account balance or $50,000. These loans usually require repayment within five years. An extended repayment period, often up to 15 years, may be available if the loan is used for the purchase of a primary residence. If the loan is not repaid according to the terms, the outstanding balance may be considered a taxable distribution and subject to the 10% early withdrawal penalty if the participant is under age 59½.

Other Key Differences

Vesting schedules determine when an employee gains full ownership of employer contributions made to their retirement plan. While employee contributions are always 100% vested immediately, employer contributions may be subject to a schedule. Common vesting schedules include “cliff vesting,” where employees become 100% vested after a specific period, often three years, and “graded vesting,” where ownership increases gradually over several years, typically reaching full vesting after six years.

Fee structures can also vary between 401(k) and 403(b) plans. 401(k) plans, particularly those offered by for-profit companies, may have higher administrative and investment management fees due to the broader range of services and investment options. Conversely, 403(b) plans, often associated with non-profit entities, might feature lower administrative costs, though some older plans with annuities can have higher underlying investment fees.

Both 401(k) and 403(b) plans can offer Roth contribution options, allowing after-tax contributions that grow tax-free, with qualified withdrawals also being tax-free. The availability of a Roth option depends on the specific plan design.

Administrative oversight also presents a distinction. 401(k) plans offered by private sector employers are generally subject to the Employee Retirement Income Security Act (ERISA), which provides regulations for plan administration, reporting, and fiduciary responsibilities. Many 403(b) plans for public education institutions and churches may be exempt from certain ERISA requirements, resulting in different levels of oversight and participant protections.