What Is the Difference Between 401(k) and 403(b) Accounts?

Saving for retirement is a fundamental aspect of long-term financial planning. Understanding various retirement savings vehicles is an important step in preparing for life after employment. These plans encourage consistent contributions and allow investments to grow, providing a financial foundation for later years. Exploring different options helps individuals make informed decisions tailored to their circumstances.

Defining 401(k) Accounts

A 401(k) account is an employer-sponsored retirement savings plan, primarily offered by private-sector, for-profit companies. Established under Section 401(k) of the Internal Revenue Code, these plans offer tax-advantaged status. Participants contribute a portion of their salary, often through pre-tax payroll deductions. This reduces current taxable income, and investments grow on a tax-deferred basis until withdrawal in retirement. Many employers also provide matching contributions, enhancing employee savings.

Defining 403(b) Accounts

A 403(b) account is a retirement savings plan for employees of non-profit organizations, public schools, colleges, universities, and certain ministers. Named after Section 403(b) of the Internal Revenue Code, these plans allow pre-tax salary contributions. Contributions and investment earnings grow tax-deferred until withdrawal in retirement. While often associated with annuities, 403(b) plans also offer mutual funds.

Key Differentiating Factors

Eligibility

The primary distinction between 401(k) and 403(b) accounts lies in the type of organizations that offer them. 401(k) plans are almost exclusively sponsored by private, for-profit businesses, ranging from small companies to large corporations. In contrast, 403(b) plans are available to employees of public schools, religious organizations, and tax-exempt non-profit organizations classified under IRC 501(c)(3), such as hospitals and charities. This fundamental difference means that an individual’s eligibility for one plan over the other is typically determined by their employer’s organizational structure.

Investment Options

Investment options often vary between the two plan types. 401(k) plans generally provide a broader selection of investment vehicles, including various mutual funds, exchange-traded funds (ETFs), individual stocks, and bonds. While 403(b) plans historically focused on annuities, they now also commonly offer mutual funds. The range of choices in a 403(b) can sometimes be more limited compared to a 401(k), influencing the diversity of a participant’s portfolio.

Contribution Rules

For both 401(k) and 403(b) accounts, the elective deferral limit for employees is $23,000 in 2024, increasing to $23,500 in 2025. Individuals aged 50 and older can make additional catch-up contributions, which are $7,500 for both plan types in 2024 and 2025. A distinct feature of some 403(b) plans is an additional catch-up contribution for employees with 15 or more years of service with the same employer. This “15-year rule” allows eligible participants to contribute an extra $3,000 per year, up to a lifetime maximum of $15,000, provided their average annual contributions have not exceeded $5,000.

Withdrawal Rules

Withdrawal rules generally align, though specific nuances exist. One common exception to early withdrawal penalties is the “Rule of 55,” which permits penalty-free withdrawals if an employee leaves their job in or after the year they turn 55, specifically from the plan of the employer they just left. While this rule applies to both 401(k)s and 403(b)s, income tax on these withdrawals still applies.

Regulatory Oversight

Most 401(k) plans are subject to the Employee Retirement Income Security Act of 1974 (ERISA), which provides strict regulations concerning reporting, disclosure, and fiduciary responsibilities to protect plan participants. Many 403(b) plans, particularly those sponsored by governmental entities or non-electing churches, are exempt from certain ERISA requirements, potentially leading to lower administrative costs for the employer. This distinction in oversight can influence plan design and participant protections.

Vesting Schedules

Vesting schedules, which determine when an employee gains full ownership of employer contributions, can also vary. While employee contributions are always immediately 100% vested in both plan types, employer contributions are subject to a vesting schedule. 401(k) plans commonly use “cliff” vesting (e.g., 100% vested after three years) or “graded” vesting (gradually increasing ownership over several years, typically up to six). Some 403(b) plans may offer shorter vesting periods or even immediate vesting for employer contributions, although this is not universal.

Common Features

401(k) and 403(b) accounts share several core characteristics. Both plan types generally allow for both pre-tax (traditional) and Roth contributions. With Roth contributions, money is contributed after taxes, allowing for tax-free withdrawals in retirement if certain conditions are met. This offers flexibility in tax strategy.

Both plans may permit participants to borrow against their account balances. These loans must typically be repaid with interest; failure to do so can result in the outstanding balance being treated as a taxable distribution subject to penalties. Hardship withdrawals are also permitted under specific IRS-defined immediate and heavy financial needs, such as medical expenses or costs related to a principal residence.

Rollover options provide continuity for retirement savings. Funds can typically be rolled over into other qualified retirement plans, like an IRA or a new employer’s plan, without immediate taxes. This allows consolidation of retirement assets and maintains their tax-advantaged status.

Finally, both 401(k) and 403(b) accounts are subject to Required Minimum Distributions (RMDs). Participants must generally begin taking withdrawals from traditional, tax-deferred accounts by April 1 of the year following the calendar year they reach age 73. Failure to take RMDs can result in significant penalties. However, if still employed and not a 5% owner, participants in workplace plans can often delay RMDs from their current employer’s plan until retirement.