401(k) vs. 403(b): Benefits & Differences

RETIREMENT PLAN 101

401(k) vs. 403(b): Benefits & Differences

The 401(k) is nearly synonymous with workplace retirement vehicles in the U.S., although it’s certainly not the only employer-sponsored plan that offers powerful tax advantages. Millions of hard-working Americans save through other retirement accounts, including the widely used 403(b).

So what, exactly, is the difference between 401(k) and 403(b) plans? While they seem almost undistinguishable at first glance, there are a few important distinctions. In this piece, we discuss some key differences and similarities.

Who can offer a 401(k) or 403(b) plan?

Whether your business or organization can offer a 401(k) or a 403(b) depends on the type of entity.

American workers love their 401(k) and 403(b) plans.

Most defined contribution account-owning households agreed that employer-sponsored retirement accounts helped them “think about the long term, not just my current needs” (91 percent), and that “payroll deduction makes it easier for me to save” (92 percent). And, 82 percent of households with plan accounts agreed that the “tax treatment of my retirement plan is a big incentive to contribute.”¹

Traditional or Roth?

The basic concept of both plans is similar. Like all other types of retirement plans, they fall into an income tax bucket of either “tax now,” “tax later” or “tax never.”

Traditional 401(k) and 403(b) plans

A traditional 401(k) or 403(b) is the most common plan type and falls into the “tax later” category. In other words, they are funded with pre-tax dollars through payroll deductions during employee’s working years and later taxed only during withdrawals in retirement. Since contributions are made with pre-tax dollars, they aren’t included in and may reduce the employee’s taxable income.

The bottom line: A traditional 401(k) or 403(b) may be a good option for those who feel they’ve hit their peak earning years and may be in a lower tax bracket in retirement.

Roth 401(k) and 403(b) plans

Both 401(k) and 403(b) plans may offer Roth features, which changes the tax advantage. Instead of investing pre-tax money, employees contribute dollars that they’ve already paid tax on so they won’t have an additional tax liability down the road. Employees can withdraw their funds (contributions and earnings) tax-free with a qualified distribution after reaching age 59½. The ability to withdraw earnings tax-free puts these Roth accounts into the “tax never” bucket. However, because contributions are made with after-tax dollars, the taxable income won’t benefit from potential reductions.

The bottom line: A Roth 401(k) or a Roth 403(b) may be a good option for those who feel they haven’t yet hit your peak earning years and believe may be in a higher tax bracket in retirement.

Comparing 401(k) and 403(b) plans

While 401(k) and 403(b) plans have similar rules, there are some important distinctions in the following categories:

Eligibility requirements

This is one of the key differences between 401(k) and 403(b) plans, and the answer differs based on the type of contributions being discussed.

Employee deferrals

There is a unique IRS rule dubbed the “Universal Availability Requirement” that applies to 403(b) plans. In a nutshell, it says that with very few exceptions, anyone who is an employee must be eligible to make deferrals immediately upon hire. 401(k) plans, on the other hand, are not subject to this requirement and can impose a waiting period of up to one year of service and attainment of age 21, and can also exclude classes of employees assuming that the plan still passes the minimum coverage test.

Employer contributions

401(k) and 403(b) plans have no difference when it comes to employer contributions. If the employer makes a matching or nonelective contribution, a 403(b) plan can impose a waiting period similar to those available in a 401(k) plan as long as, of course, all employees are permitted to make salary deferrals.

Contribution limits

This is another area where 401(k) and 403(b) plans are generally similar. The amount employees can tuck away annually is the same regardless of which plan is offered by the employer. Additionally, if employees are age 50 or older, both plans provide a catch-up feature that allows employees to contribute an additional money on top of the annual contribution limit:

403(b)s have a separate catch-up rule for employees with at least 15 years of service at the same organization. The IRS has a formula for this additional amount, which can go as high as $3,000 a year for certain workers. However, the calculation is complex and requires accurate employee data.

The SECURE Act 2.0 and catch-up contribution changes in 2025

Starting in 2025, employees turning 60, 61, 62 or 63 can tuck away the regular catch-up plus an additional amount limited to $10,000, or 150% of the dollar amount, thanks to the SECURE Act 2.0 that was passed into law in December 2022.

Investment options

Employees are typically offered a pre-selected menu of investment options for either a 401(k) or 403(b). In both cases, these choices can include index funds, mutual funds and target-date funds.

Non-discrimination testing

Both 401(k) and 403(b) plans are required to satisfy most of the nondiscrimination rules.

One key exception is the ADP test that normally applies to salary deferrals. As a trade-off to the Universal Availability Requirement (described above), 403(b) plans get an automatic pass on the ADP test. This allows executives and any highly compensated employees to maximize their deferrals.

Participant loans

Both retirement plans can offer participant loans, which represent another option for employees in dire need financially. These plans can provide loans of up to 50% of the employee’s vested balance or $50,000, whichever is less.

While loans have several appealing features, it’s important to weigh the pros and cons caref

Both 401(k)s and 403(b)s require employees to pay back the loan within five (5) years, although that may be extended if an employee is using the funds to purchase a primary residence.
Both 401(k) and 403(b)s require that employees pay interest—generally a percentage point or two over the prime rate—but unlike traditional loans, this interest goes into the employee’s own account.

So which is better – a 401(k) or 403(b)?

Both are powerful savings vehicles, and one isn’t necessarily better than the other.

Most employers don’t have a choice of which plan to use, so the important thing to focus on is the goal and objectives of the business or organization. While 403(b) plans are available for nonprofits and government employers, 401(k)s are generally offered by for-profit companies. And while 401(k)s permit more sophisticated investment instruments, 403(b)s get automatic pass on certain non-discrimination testing.

How do we decide which plan is right for my business or organization?

We kept the “easiest” question for last. Contact NESA and we’ll help you make the right decision.

Choose the Right Plan for Your Business or Nonprofit

NESA Plan Consultants (NESA) is a retirement plan provider working with advisors, recordkeepers and CPAs to offer customized 401(k), 403(b) and 457(b) plans. NESA offers modern solutions and provides resources to employers and employees to secure a brighter financial future.