Understanding 401(k) vs. 403(b) Retirement Accounts

If you're a new investor, you might have questions about 401(k) vs. 403(b) plans. Both let you contribute pre-tax earnings toward your retirement. While these retirement plans offer similar benefits, they're sponsored by different types of employers. 

How Do 401(k) and 403(b) Plans Work?

When the company you work for offers a sponsored retirement plan, it could be either a 401(k) or 403(b), depending on the type of organization. With both plans, you set aside money for retirement before taxes, which lowers your taxable income. Often, employers match your contributions up to a certain amount, and some companies also offer profit-sharing on these plans.

The money in the account accrues on a tax-deferred basis, which means you don't pay taxes until you retire and begin to take withdrawals from your investments. At that point, you must pay income taxes on the money according to your tax bracket at the time of withdrawal. 

What Are the Differences Between 401(k) vs. 403(b) Plans?

You probably have a 401(k) plan if you work for a private, for-profit company. On the other hand, if you're employed by a government organization, such as a public school, or a nonprofit organization, you may have a 403(b) plan for retirement.

A 403(b) plan is also exempt from many of the provisions of the Employee Retirement Income Security Act. Under ERISA, 401(k) plans must perform annual nondiscrimination tests to ensure that highly compensated or management employees don't receive an unfair share of plan benefits. In contrast, this requirement only applies to 403(b) plans if your employer makes contributions on your behalf (matching funds, for example).

In addition to these current differences, the two types of plans once offered different types of investments. Until 1974, you could only invest 403(b) funds in annuities. Both plans offer investment options in various asset classes, including stocks, bonds and commodities. However, 403(b) plans include only registered investment funds, while 401(k) plans may also include unregistered funds.