Is a 403b Better Than a 401K?
Both 401(k) and 403(b) retirement plans allow employees to set aside tax-friendly payroll deductions towards saving for retirement, with some employers even matching some participants’ contributions.
There are a number of differences between these two accounts. Some notable features include investment options (403(b)s were once restricted to annuities only but now offer mutual funds as well) and vesting schedules.
1. Tax-deferred growth
A 403(b) plan provides tax-deferred savings accounts to employees at public schools, churches, and charitable 501(c)(3) tax-exempt organizations. Employers make available 403(b) accounts in order to attract and retain talent.
Employee salary deferrals into a 403(b) are made pretax and accumulate tax-deferred until withdrawal is taken out from the plan at retirement time, when income taxes must be paid as well as possible early-withdrawal penalties of 10% until you reach age 59 1/2.
As with 401(k) accounts, many 403(b)s offer an array of investment choices; however, some plan providers offer limited choices and higher fees, which could limit your growth potential and could erode returns over time. It is therefore wise to research any employer-sponsored plans before contributing any money.
2. Higher contribution limits
Many 403b plans include guardrails to help prevent over-contributing each year. If this does happen, however, and you contribute an excess amount, then that amount must be reported on your tax return, subject to taxes on it and may incur an early-withdrawal penalty of 10% when withdrawing it later on in retirement.
Compounding By contributing pretax dollars to savings accounts and investments, compounding will give them the potential to grow significantly over time thanks to compound interest: when investment returns generate further returns that increase your money faster than it would have done without these contributions.
Most 403b plans allow you to defer up to $22,500 annually, including employer contributions. And beginning in 2025 under Secure Act 2.0, employees aged 60-63 may qualify for an additional catch-up contribution limit of $7,500 if their plan supports it – take full advantage of it!
3. Tax-free withdrawals
Assuming you meet certain requirements, withdrawing funds from a 403b without penalty can be done at any time, though tax must still be paid on any after-tax contributions you made. It is essential that when planning for retirement you keep this fact in mind – speaking to a financial advisor can assist in keeping with compliance standards while helping achieve your retirement goals.
Employers frequently offer 403b accounts that offer a diverse selection of investments, such as mutual funds, index funds, target-date funds and fixed or variable annuities. You can select an option that meets both your risk tolerance and time horizon; just remember that all underlying investments carry risks of their own and you should diversify to reduce overall risk. Also make sure that fees are carefully considered; high-fee investments could substantially lower returns in the long run.
4. Loans
A 403b plan allows you to borrow from your retirement savings at a relatively low interest rate – usually just one or two points higher than bank base interest rate and much lower than personal loan and credit card interests. What’s more, any money paid on 403b loans goes back into your own account rather than being siphoned off by financial institutions as with traditional personal loans. But borrowing against yourself comes with certain restrictions: repayment will be made using post-tax dollars and penalties may apply should you leave or default.
The Internal Revenue Service limits how much of your vested account balance you can borrow as part of an IRS loan, up to 50% or $50,000 – whichever comes first. Your employer may place additional restrictions on loan amounts, repayment terms and other details.
5. Investment options
Like 401(k) plans, 403b plans allow you to defer part of your paycheck on a pre-tax basis and invest it into various investment vehicles such as mutual funds and exchange-traded funds (ETFs).
However, certain 403b providers charge excessive fees that could compromise your retirement savings. According to research cited by The New York Times in 2016, millions of teachers enrolled in “bad” 403b plans lose $10 billion each year as a result of excessive fees.
Some organizations that provide 403b plans also offer employer match contributions – money your employer adds into your plan in addition to what you put in. Employer matching contributions are an excellent way of increasing retirement savings – be sure to take advantage of them as soon as you’re eligible!
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