403b vs 401k: What's the Difference?

When it comes down to a 403b vs 401k employer retirement plan, there is not much of a difference. Both offer pre-tax (traditional) retirement savings options. Since 2006, employers who sponsor these plans can amend them to allow post-tax (Roth) contributions as well.

By the way, all those numbers and letters refer to the section where all the rules, regulations, and updates can be found – sections 401(k) and 403(b) of the Internal Revenue Code. 

403b vs 401k plans comes down to who sponsors them. 403(b)s, which have been around since 1958, are limited to public education entities, some non-profits, certain hospitals, governmental organizations, and self-employed ministers in the USA.

Taxed-sheltered annuity?

I still hear 403(b)s referred to as tax sheltered annuities. Back in 1974, section 403(b) was amended so organizations could offer mutual fund choices in addition to an annuity option.

Since that time, annuities and pensions have slowly become more and more rare. Defined contribution plans, where the responsibility is shifted from the employer to the employee, rule the roost.

Even though your 403(b) may still be referred to as a tax-sheltered annuity, most likely it’s operated just like a 401(k), where you’re given a basket of mutual funds to choose from and it’s up to you to come up with an investment plan.   

401(k) is for everyone else

The administrative processes, paperwork and associated costs of running a 403(b) are much less than running a 401(k), giving these types of organizations with small budgets the ability to help their employees save for retirement.

Private sector businesses are left with running 401(k)s for their employees. The complex rules, designed to make sure employees are treated fairly when it comes to their retirement, make these plans more expensive to run and manage.

Different fairness tests

One 403b vs 401k difference involves the universal availability rule versus the ADP and ACP tests. The universal availability rule, which applies to 403(b) plans, simply means that the 403(b) plan must be made available to all employees (certain specific exceptions apply) of that organization.

A 401(k) administrator, on the other hand, must prove to the IRS not only that it is universally available to most employees, but that the plan does not favor the more highly paid employees versus the lower paid employees in the organization. If these ADP and ACP tests prove otherwise, certain highly compensated employees will have their 401k contribution limits reduced.

These tests can be difficult to pass and are complicated and expensive to compute. Safe Harbor 401(k) plans don’t have to pass these tests, but other restrictions apply.

Conversion flexibility

Rules regarding rollovers and conversions have been simplified. Basically, there is no difference between 401b vs 401k plans when you change employers. You can roll a 403b plan into a 401k plan and vice versa when you change jobs.

Be sure and execute what’s known as a “trustee to trustee” transfer when rolling money from one plan to another: That’s when money is passed from one plan directly to the other plan rather than through you. Otherwise, you could get hit with tax plus a 10% early withdrawal penalty.

Most employer's give you the option of leaving that old 401(k) or 403(b) plan right where it is. You can’t contribute to it anymore, but you can still manage the assets just as you did when you worked there.

Another option is rolling that old 401(k) or 403(b) plan into a traditional IRA or Roth IRA.

Difference between 403b vs 401k plans? Not much...

Any 403b vs 401k plan differences are minimal from an employee perspective. Employers are the ones that have to grapple with the added regulations, restrictions, and paperwork when creating and managing a 401(k) plan.