403b vs 401k

403b vs 401k: Differences and Similarities

The primary difference between a 403b vs 401k retirement account is who uses them.

A 401k is for people employed by a for-profit organization.

In contrast, the 403(b) plan is for those who work for a non-profit organization. Some typical examples include teachers, members of religious organizations, and hospital employees.

This is the key difference because it is unlikely you’ll have a choice between the two plans. It just depends on the type of employer you work for.

The different numbers and letters of the two types of plans refer to the section of tax code that describes them.

Other Differences and Similarities Between the Two Plans

In general, these two plans work much the same way. The Internal Revenue Service (IRS) allows you to request your employer to deduct a specified amount from your paycheck and redirect it towards retirement savings. One of the most attractive benefits of both plans is that you do not pay federal income tax on the redirected funds when you have them withheld from your paycheck. However, you will need to pay these taxes when you withdraw from your savings plan after retirement.

403b vs 401k Vesting

Each account is also subject to vesting rules. Vesting means that you must work for an employer for a specified number of years before you can receive the full amount of the employer contribution when you leave the company or retire. Each plan is subject to the same vesting rules, but they sometimes differ in practice.

A typical 401(k) vesting schedule provides the employee with 20 percent of the employer contribution for every year of service. For example, an employee who resigns one year after enrolling in a 401(k) might receive 20 percent of the employers contributions. An employee who stays five years or longer would receive 100 percent of it.

Although they are subject to the same legal guidelines the 403(b) vesting schedule tends to require fewer years of service before the employee can keep the full amount of the employer contribution. As a professor I have worked at two different institutions that both had immediate vesting. That means any employer matching contribution was 100% mine the moment it hit the account. This is very common among 403bs.

In either case, the vesting schedule is outlined in the plan documents provided by your employer.

Maximum 403b vs 401k Contribution Amounts

For 2020, the IRS allows participants in a 403b and 401k plans to set aside up to $19,500 on a pre-tax basis if under age 50.

Those over age 50 may contribute an extra $6,500 for a maximum of $26,000.

You have until April 16, 2021 to make contributions that you will report on your 2020 tax return. The date is normally April 15. However, the IRS moves it to the closest Monday when April 15 falls on a weekend.

The IRS updates these amounts every few years to account for inflation and ensure that retirement savers are able put back enough to support themselves in retirement.

Special 403b Catch-Up

As with many IRS rules, there is an exception to this. The IRS allows an additional catch-up amount for 403b participants who have worked for the same non-profit organization for 15 years or longer. It allows you to contribute an additional $3,000 per year for five years.

To be eligible, you must have previously contributed less than $5,000 per year to your 403(b) and meet the years of service requirement. This stipulation does not require you to be a certain age.

Special 403b Rules for Part-Time Workers

If you work part-time for a non-profit organization, the IRS allows you to contribute to an employer-sponsored 403(b) under certain circumstances. These include:

  • Your employer normally schedules you to work 20 hours or more per week
  • You must contribute at least $200 per year towards the plan
  • You cannot participate in another 403(b) plan at the same time

Transferring Your 403b vs 401k Account to a New Employer

Perhaps you have worked as a teacher for several years and want to make a career move to non-profit administration. Or, maybe you want to take a job in the for-profit sector?

The good news is that rolling over the funds in your 403(b) account is much easier than it once was.

You can roll either type of account into an IRA. The IRS also allows you to transfer your retirement savings account to a new employer.

Upon hire, you can transfer the funds to a new 403(b), a 401(k), or another approved retirement savings account. This enables you to keep the same account for a lifetime no matter how many career changes you might have.

Distributions from 403b vs 401k Plans

The minimum age to withdraw from both plans is 59.5. The IRS allows people who have reached that age threshold to start taking withdrawals from their retirement account whether they still work for the employer or not. However, plan rules may prevent withdrawals if you are still working.

Except in certain circumstances, you will have to pay a 10 percent early withdrawal penalty if you transfer funds out of the account before you reach age 59.5. The exceptions include the following:

  • You must make payments under a qualified domestic relations order
  • Your employer has released you from service and you now receive regular payments from your 403(b) account
  • The IRS has imposed a levy on your 403(b) assets
  • Your employer has separated you from service and you are age 55 or older
  • You must remedy excess contributions
  • You are fully or partially disabled
  • You incur medical expenses for which you won’t receive reimbursement
  • You pass away, leaving the account manager to make payments to your beneficiary

The IRS requires all 403(b) participants to begin accepting distributions at age 70.5 or 72 unless still working and contributing to a plan. If you fail to do so by April of the year after you reach this age threshold, the IRS will impose a 50 percent excess accumulation penalty.

Regardless of when you withdraw, you will pay taxes at your marginal tax rate based on your income tax bracket.

Investing in a 403(b) is a Smart Financial Move

You wouldn’t pass up free money if you got a check in the mail, but too many people do this by failing to enroll in an employer-sponsored 403(b) account. If you’re eligible and your employer offers it, choosing to defer money from each paycheck towards retirement savings is one of the best financial gifts you can give yourself.

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