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What is the Difference Between a 401k and 403b?

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  • Written By: D. Waldman
  • Edited By: Lauren Fritsky
  • Last Modified Date: 23 February 2020
  • Copyright Protected:
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With the growing decline in companies offering traditional pension plans, more and more employees are having to rely on self-directed retirement planning, such as 401k and 403b plans, in order to ensure they will have a source of income later in life. The primary difference between these plans is that 401k plans are offered by most for-profit companies, while 403b plans are offered by non-profit organizations. While the basic structures of 401k and 403b plans are the same, many of the benefits that each offer can vary greatly. Aside from the types of companies able to offer either 401k or 403b plans, the other differentiating factors lie in the availability of employer contributions and the nature of employer ownership of the plan.

In essence, both 401k and 403b plans allow the employees to set aside pre-tax dollars from their salaries to be invested in their retirement funds. Both plans are also subject to the government-defined contribution limits for pre-tax dollars. Employees of public companies do tend to benefit more from a 401k plan, primarily due to the additional monies their employer will contribute to the plan. Non-profit companies tend to offer richer non-monetary perks, such as vacation, personal time, and fringe benefits. These types of benefits are typically designed to offset the reduced financial benefit of a 403b plan when compared to a 401k plan.

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A traditional 401k plan is often funded in one of three ways. The largest contribution comes from the employee electing to contribute a percentage of each paycheck to his 401k plan on a pre-tax basis. Many employers also offer the added benefit of matching the employee contribution dollar for dollar up to a fixed percentage. Due to the decline of pension plans, employers are also known to make regular lump-sum contributions to the employee's 401k plan based on company dividends and applicable company performance bonuses.

A 403b plan, on the other hand, only offers a single funding method. With a 403b plan, employers are structured as entities such as charities, research facilities, schools, and hospitals. Employees are still eligible to contribute a percentage of their pay to their 403b plan—however, employer contributions are not allowed. Since there is no profit being made by the company, there are no dividends to pay out. The lack of profit also eliminates the company's available funds for matching employee contributions.

The other difference between 401k and 403b plans lies in the ownership of the plan. A 401k plan is owned and managed by the employer, allowing them to have a large influence over investment opportunities offered and employer matching and other contributions. This direct ownership, however, also makes the plan subject to regular testing to ensure that it is being administered fairly and not benefiting any one group of employees more than another. A 403b plan, on the other hand, is completely owned and managed by a third party, removing any liability or administration duties the employer would normally hold.

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