A lot of letters and numbers are often thrown around in reference to retirement plans. What are they and what differences and similarities do they have?
Though they sound like droids from a galaxy far, far away, 401(k) and 403(b) are not contemporaries of C3PO, R2-D2, and BB8. They are types of qualified retirement plans. I know, it would have been a lot more fun if they had been blaster-toting droids, wouldn’t it?
But, even if they are not very cool, they are very helpful. As qualified retirement plans, they offer tax advantages for retirement savers. “Qualified” just means that they follow the IRS’s rules.
How They Are Named
Before we get into the details, what do you think of those names? Think you might use one for your next kid? Please don’t.
George Lucas didn’t name these retirement plans, rather they are named after the sections of the Internal Revenue Code that authorize them. Kind of like how we talk about John 3:16. The rules permitting the establishment of a 403(b) plan are found in 26 U.S. Code § 403, section (b).
Type Of Provider
The big difference between these creatively named retirement plans is who is allowed to sponsor, or provide, them. A 401(k) plan can only be offered by a for-profit business. That’s why you always hear people refer to “my company’s 401(k).” So don’t bother asking your church to start a 401(k); they can’t.
Churches can, however, sponsor a 403(b) plan. These plans are for tax-exempt, non-profit institutions, like schools, hospitals, charities, and yes, churches.
There are some other differences between 401(k)s and 403(b)s as well. While they both allow employers to make matching contributions, it is much more common among 401(k) plans. If you are offered a match for your 403(b) you are very, very lucky.
Only 401(k) plans can offer profit-sharing programs. Sponsors of 403(b)s, by definition, don’t have profits to share. They are non-profit organizations. Also, they have no ownership over a 403(b) plan, their only obligation is to deposit employee salary deductions into the account.
A 403(b) is usually exempt from the Employee Retirement Income Security Act (the law governing retirement plans), so it will have a much easier review and certification process. They aren’t required to do “discrimination testing” like 401(k) plans are and they don’t require special accounting. Overall, 403(b) plans are less complicated administratively for the sponsoring organization.
Similarities Between 401(k) Plans And 403(b) Plans
If you’re not familiar with these qualified retirement plans, you may be wondering what their similarities are, aside from their imaginative monikers. Here they are:
- They provide for pre-tax salary deferrals (you don’t have to pay income taxes before investing your money)
- They have the same contribution limits ($18,000 for 2017, with an extra $6,000 for those over 50)
- The IRS charges a 10% penalty if you withdraw money before you reach age 59 ½
- You can put your money in a number of investments, including stocks and bonds
- They are a great way to save for retirement
If you have access to a 401(k) or 403(b) plan at work you have been given a great gift. The tax savings they provide will give an amazing boost to your retirement savings. Take advantage of this opportunity you have. Many people wish they were in your shoes.