Financial Literacy Friday: 401k vs 403b
It’s the end of the week which means another edition of Financial Literacy Friday, and this one will be focusing on the differences between 401k and 403b retirement plans. Because I work with nurses and doctors, many of them are able to access 403b plans and are curious as to how they differ from 401k’s and which are better. The basic answer is that both plans are retirement shelters that for the most part take pre-tax money and allow it to grown and compound interest free. When the money is withdrawn in retirement it is charged at a lesser tax rate because you will have retired and therefore paying less tax. Let’s start with 401k’s as that’s the more familiar plan for most people.
The 401k is an employer sponsored retirement plan used by for profit companies in order to provide tax deferred status to retirement funds. These are much more likely to have an employer match, and while there are various ways to accomplish that a common match is the employer will match 50% of employee contributions up to 6%. So if you contribute 6% of your paycheck to the retirement fund, the employer will kick in another 3% giving you a total of a 9% contribution. You are free of course to contribute more, but the employer won’t match beyond that 6% in this example.
401k plans also usually come with a vesting period that can be up to 5 years long. This means that the money in the retirement plan becomes fully yours after 5 years or whatever the vesting period dictates. This is important for those that may not hit the vesting requirement in terms of years of service and the company will be able to retain some of the funds in the account. Given that younger people are prone to switching jobs, this is definitely something to be aware of as you look at job opportunities.
The 403b plan is an employer sponsored plan for non-profit companies and government employees, so many hospitals, schools, and religious institutions qualify. These plans also serve as a retirement shelter that provides tax deferred growth and compounding of funds. 403b’s are also not subject to ERISA (Employee Retirement Income Security Act) if the employer does not fund employee accounts or provide a match. Because of this, the expense ratio in these plans is usually much lower as they generally do not provide a match to employee contributed funds in order to avoid being subject to ERISA. While both plans function in much the same way, there are two major differences, the investment options and the MAC.
One of the differences in these plans is the investment options within the retirement plans. For 401k’s, it depends on who the plan trustee is but can run from several mutual funds and company stock to whatever the trustee is able to offer. With 403b’s, they are often overseen by insurance companies, which means that you’ll be provided a variety of annuity options as opposed to mutual funds, which we’ll get into in a later edition of Financial Literacy Friday.
One edge that the 403b has over the 401k is the MAC or Maximum Allowable Contribution that allows those who have 15 years of service with the employer bump up their contributions by $3,000 per year. 401k’s don’t have this provision, but when looking over the plan please check it carefully as it may not be included at smaller employers due to them not being aware of the provision. Unfortunately, if it’s not in the plan, you won’t have access to this perk.
For those who are going to be working with 403b’s, this gives you some things to look out for and what to expect from the plans. If you need more help going over the plan documents and figuring out what makes sense, let me know and I’ll be happy to go over everything with you.