Both 401(k) and 403(b) plans are employer-sponsored retirement plans that offer tax-advantaged savings. Structurally, the types of plans are similar. Whether you participate in a 401(k) or a 403(b) plan, you can make tax-deductible contributions and enjoy tax-deferred earnings, and your employer may even make additional contributions to your account. The main differences lie in the eligibility of participants and the reporting requirements for employers.
While most large for-profit employers can offer a 401(k) plan to employees, only certain types of organizations can offer a 403(b) plan. Typically, 403(b) plans are offered by public schools, non-profit companies or tax-exempt organizations known as 501(c)(3) organizations. To qualify under Section 501(c)(3) of the Internal Revenue Code, an organization must be organized for an "exempt purpose." Common examples include scientific, religious, educational or charitable organizations. If you want to participate in a 403(b) plan, you must be an employee of one of these qualifying organizations.
Basic contribution limits are the same for both 401(k) and 403(b) plans. As of 2012, qualifying employees could contribute up to $17,000 to their plans, as long as this did not exceed 100 percent of their earned income. Employees 50 and older could contribute an additional $5,500 annually to either plan as a "catch-up" contribution. Certain employees with at least 15 years of service could contribute a further $3,000 per year to their 403(b) plan, up to $15,000 total, with employer permission. This permission does not exist for 401(k) plans.
Investment options for 401(k) and 403(b) plans are determined by the financial services company that administers the plan. Typically, a 401(k) plan is managed by a mutual fund company, whereas a 403(b) is administered by an insurance company. As a result, 403(b) plans traditionally limited investment options to annuity contracts. However, 403(b) plans have grown to offer a wider range of investment options, including mutual funds and annuity products. Most 401(k) plans still offer mutual funds as the primary investment option, but many offer guaranteed investment contracts or other insurance products as well.
As a participant, you generally don't have to pay any upfront sales charges to buy the investments in your 401(k) or 403(b) plan. However, you will still have to pay the ongoing management and service fees that retirement plan investments charge, known as the expense ratio. Insurance and annuity products often charge higher fees than mutual funds, though this is not always the case. It usually costs an employer less to offer a 403(b) plan than a 401(k) plan simply because a 403(b) is subject to fewer IRS reporting requirements.
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- IRS: 401(k) Resource Guide, Plan Participants, 401(k) Plan Overview
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- IRS: Publication 571, 403(b) Basics
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- FINRA: Investment Options
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