Tax Sheltered Annuity vs. 401(k): What’s the Difference?
While both 403(b) and 401(k) plans help you save for retirement, your employer's sector dictates which one is available and its underlying rules.
While both 403(b) and 401(k) plans help you save for retirement, your employer's sector dictates which one is available and its underlying rules.
Tax-Sheltered Annuity (TSA) plans, more commonly known as 403(b) plans, and 401(k) plans are employer-sponsored retirement savings vehicles. Named after sections of the Internal Revenue Code, they help employees save for retirement on a tax-advantaged basis. Contributions are made on a pre-tax basis, reducing your current taxable income, and investments grow tax-deferred until withdrawal. While their purpose is similar, they have differences in structure and rules that dictate who can participate, how much can be saved, and what protections are afforded. The choice between these plans is determined by the type of organization an employee works for.
The primary difference between a 403(b) and a 401(k) plan is which employers can offer them, which directly determines an employee’s access to one plan over the other.
A 403(b) plan is available exclusively to employees of public educational institutions and certain non-profit, tax-exempt organizations. This includes teachers, administrators, and staff at public schools, colleges, and universities. Employees of organizations classified under Internal Revenue Code Section 501(c), such as hospitals and religious institutions, are also eligible.
In contrast, 401(k) plans are the retirement savings vehicle offered by private, for-profit companies. An employee’s eligibility is a direct consequence of their employer’s tax status.
Additionally, 403(b) plans often operate under a “universal availability” rule. This requires that if an employer permits one employee to make elective deferrals, it must extend that opportunity to all employees. A 401(k) plan may have more specific eligibility requirements, such as a minimum length of service or hours worked, before an employee can participate.
For 2025, the base amount an employee can contribute through salary deferral, known as an elective deferral, is the same for both plan types at $23,500. This represents the maximum amount an employee can direct from their paycheck into their retirement account for the year.
Both plans also allow for catch-up contributions for participants who are age 50 or older. For 2025, this additional amount is $7,500, allowing eligible participants to contribute a total of $31,000. A newer provision, effective in 2025, allows participants aged 60, 61, 62, and 63 to make an even larger catch-up contribution of $11,250, if the plan adopts this feature.
A unique feature exclusive to 403(b) plans is the “15-year rule” catch-up contribution. This provision allows certain long-tenured employees to contribute an additional amount if they have completed at least 15 years of service with the same eligible employer. The rule is designed for those who may have contributed less in earlier years of their career.
An eligible employee can contribute up to an additional $3,000 per year, with a lifetime maximum of $15,000 from this provision. The actual amount is the lesser of $3,000, the $15,000 lifetime limit reduced by prior use, or a figure derived from a formula of $5,000 multiplied by years of service, minus total prior elective deferrals. If a participant is eligible for both the age 50+ catch-up and the 15-year rule, contributions are applied first to the 15-year limit.
The total amount that can be contributed to a plan from all sources—including employee deferrals, employer matches, and other employer contributions—is also capped. For 2025, this overall limit under IRC Section 415 is $70,000, which increases to $77,500 for participants eligible for the age 50+ catch-up.
Historically, the investment choices within 403(b) and 401(k) plans were distinct. The 403(b), true to its “tax-sheltered annuity” name, was primarily limited to annuity contracts, while 401(k) plans have traditionally provided a broader spectrum of mutual funds. While regulations have allowed 403(b)s to include mutual funds, the legacy of annuities remains a common feature.
Many modern 403(b) plans offer an investment lineup that mirrors a 401(k), but the potential for a more limited or annuity-focused selection still exists. A feature now common to both plan types is the ability to make Roth contributions. This allows an employee to contribute money on a post-tax basis, so qualified withdrawals in retirement are tax-free.
Plan loans are another feature available in both types of plans, subject to the employer’s plan design. The rules are parallel, permitting a participant to borrow up to 50% of their vested account balance, with a maximum loan amount of $50,000. These loans must be repaid within five years, with interest.
A distinguishing feature is the application of the Employee Retirement Income Security Act of 1974 (ERISA). Most 401(k) plans are subject to ERISA, a federal law that sets minimum standards for plan administration, fiduciary conduct, and disclosures.
Many 403(b) plans, particularly for governmental entities like public schools, are exempt from ERISA requirements. This exemption often occurs if the employer’s involvement is limited, such as not providing employer contributions. The absence of ERISA coverage means participants may have fewer legal protections regarding fiduciary oversight and plan transparency.
The rules governing how and when money can be taken from 403(b) and 401(k) plans are largely similar. For both plan types, participants can begin taking distributions without penalty upon reaching age 59½. Withdrawals from traditional, pre-tax accounts are taxed as ordinary income, and an early withdrawal generally incurs a 10% penalty tax on top of the ordinary income tax.
Both 401(k) and 403(b) plans may offer hardship withdrawals, though they are not required to do so. A hardship withdrawal is a distribution made because of an “immediate and heavy financial need,” with the amount limited to what is necessary to satisfy that need. The IRS provides “safe harbor” events that meet this criterion, including certain medical expenses, costs to purchase a principal residence, and tuition payments.
Recent legislation has aligned the rules for hardship withdrawals. For both 401(k) and 403(b) plans that permit them, distributions can be made from employee contributions and their earnings. Other rules have also been standardized, such as eliminating the requirement to take a plan loan first and removing the six-month suspension of contributions that once followed a hardship withdrawal.
Upon separating from service with an employer, participants in both plans have similar rollover options. They can leave the money in the old plan, roll it over into a new employer’s plan if permitted, or roll the funds into an Individual Retirement Account (IRA). A direct rollover, where funds are sent from one financial institution to another, is a non-taxable event. An indirect rollover, where the participant receives a check, requires the funds to be deposited into a new retirement account within 60 days to avoid taxes and penalties.