401(k) vs. 403(b) plans: A guide for employers

💡 Key takeaways:

• Generally, any business can offer a 401(k) plan. However, only certain types of organizations can offer a 403(b) plan.
• Both types of plans allow for employer contributions.
• 403(b) plans have fewer investment options than 401(k) plans.
• Some organizations may offer both a 403(b) and a 401(k) plan.

As an employer designing a retirement benefits program, you likely have many priorities to juggle. You may be thinking: What types of plans will my employees want? What will be affordable for the company? What will be easiest to manage?

Luckily, if you’re considering offering 403(b) or 401(k) plans, we’ve got you covered. The only thing you need to know now is that both 401(k) and 403(b) plans are employer-sponsored tax-advantaged retirement savings plans. We’ll dive into the rest below.

What is a 401(k) plan?

A 401(k) plan is a defined-contribution retirement savings plan many businesses offer their employees. The tax code that ushered in 401(k) plans was enacted in 1978. At a high level, 401(k) plans help individuals save for retirement, while also having rules to help make the plans fair for everyone.

401(k)s plans are typically subject to ERISA rules, which are similar to IRS rules but have a few additional requirements. The rules can be pretty technical, which is why it is worth considering having a 401(k) provider like Guideline help you craft your plan and keep it compliant.

What is a 403(b) plan?

A 403(b) plan, also called a tax-sheltered annuity or TSA plan, is a retirement plan that can only be offered by public schools, churches, and certain 501(c)(3) charities. Most 403(b) plans are defined contribution plans. 403(b) plans are sometimes called an “annuity plan” because employees could only invest in annuities when it was invented in 1958. That changed in 1974 when the government added the ability to also invest in mutual funds via a custodial account.

Generally, all employees must be allowed to contribute to a 403(b) plan. This is because of something called universal availability, which says that if any employee is allowed to participate in the plan, then all employees must be given a chance to participate. However, there are a few specific exemptions to this, outlined by the IRS in detail if you want more information.

Similarities between 401(k) and 403(b) plans

Beyond both being employer-sponsored tax-advantaged retirement savings plans, 401(k) and 403(b) plans have many other similarities. These include:

• Contribution limits: These plans have similar contribution limits. In 2024, the max you can save with a 401(k) or 403(b) plan is $23,000 annually, plus $7,500 in catch-up contributions for those age 50 and up.
• Tax treatment: A traditional 403(b) has the same tax advantages as a traditional 401(k), meaning an employee can contribute pre-tax funds, and they will be taxed upon withdrawal. A Roth 403(b) is like a Roth 401(k), where an employee can contribute post-tax funds, but they won’t be taxed upon withdrawal (as long as the distribution is qualified).
• Early withdrawal penalties: Both plans are subject to early withdrawal penalties if you withdraw funds before age 59 ½ without a valid reason for the distribution.
• Required minimum distributions: Both plans typically require participants to take required minimum distributions starting at age 72 (or 73, depending on your birth date).

Key differences between  401(k) and 403(b) plans

Some key differences exist between 403(b) and 401(k) plans. These include:

• Availability: As discussed above, 403(b)s are only available to not-for-profits, public schools, certain state governmental organizations, and churches. 401(k)s are available to private sector businesses, including nonprofits. Generally, most governmental organizations cannot offer a 401(k) plan. Some organizations, like large universities, may even offer both a 403(b) and a 401(k).
• Investment options: 403(b) plans are a bit more limited in investment options than 401(k) plans. 403(b)s were historically only invested in annuities, though nowadays, they may also be invested in mutual funds via a custodial account. 401(k)s have more investment options, including stocks, bonds, and mutual funds.
• ERISA coverage: Most 401(k) plans are subject to ERISA rules (exceptions exist for governmental plans and owner-only plans, for example). 403(b) plans offered by churches, most public schools, and state governmental organizations are generally exempt from ERISA coverage unless they specifically elect otherwise. 403(b) plans established by not-for-profits are generally covered by ERISA. However, if they meet the strict requirements under the employer non-involvement rule, they may be exempt from ERISA. If, for example, the employer offers employer contributions in the 403(b) plan or is involved in the approval of distributions, the plan would become subject to ERISA rules. So, some employers may choose not to offer contributions towards 403(b) plans because they wish to avoid dealing with ERISA rules and regulations. Note that these plans are still subject to all of the IRS regulations.
• Special contribution rules: Some 403(b) plans allow employees with 15-years or more of service to make additional catch-up contributions. Check out the IRS rules on this if you’d like to learn more.

401(k) vs 403(b) compared

Can an employee roll a 401(k) into a 403(b) and vice versa?

As you think about crafting a retirement plan that works for your company and your employees, you may consider rollovers. It’s a question that can arise, especially if you’re hiring new employees moving from the private to the public sector. So, let’s take a closer look.

Employees may rollover funds from a 401(k) into a 403(b) and vice versa if both plans allow it. If done correctly, they won’t owe taxes on this movement. However, if the employee has “mixed funds” (meaning both pre-tax and after-tax contributions), they must pay extra attention to ensure the funds go to the right type of account so they don’t owe additional taxes.

It’s always a good idea to encourage your employees to get expert financial advice, especially when it comes to their retirement goals. If your employees come to you with questions about rollovers, it’s smart to direct them to discuss this with a tax or retirement planning expert, so they can create the plan that works best for them.

Choosing the right plan

If you’re thinking of offering a 401(k) or a 403(b), the decision may already be made for you if you run a for-profit business. In that case, you only have the option of offering a 401(k). But if you’re at the helm of a not-for-profit or church, you may be able to choose between a 403(b) or a 401(k) — or both. Some factors you may want to consider are the availability of investment options and your employees’ stated preferences, if they have any.

A final important point is that it is possible to offer both plans. This may be a good option for large organizations that want to offer their employees a wide array of options.

As you begin to plan out your company’s retirement benefits offerings, it can be a good idea to contact someone with expertise to confirm you are not only compliant, but also crafting a benefits package that works well for you and your team. Don’t worry — Guideline can help.

Disclosures:

The information provided herein is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein.