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403(b) vs. 401(k): What's the difference in these retirement accounts?

James Royal, Ph.D., Bankrate.com on

Published in Business News

If you’re looking at retirement accounts, then you may come across the 403(b) and the 401(k) plans. Both the 403(b) and 401(k) are among the best retirement plans available, and one key difference between them is relatively simple: the group of workers that is allowed to use them.

Here’s how 403(b) and 401(k) plans work and their major differences.

403(b) vs. 401(k): How they work

Both 403(b) and 401(k) accounts offer workers the ability to save money for retirement on a tax-advantaged basis: in traditional versions of the plans or Roth versions.

—In traditional, pre-tax versions of the 403(b) and 401(k) plans, workers can contribute to the account and avoid tax on their contributions. The money can grow in the account on a tax-deferred basis, and then is taxed only when it comes out of the account. Savers can also invest in potentially high-return assets such as stock funds.

—In Roth versions of the 403(b) and 401(k) plans, workers can contribute to the account with after-tax money. The money can then grow in the account on a tax-free basis, and it can be withdrawn in retirement tax-free as well. As with the traditional versions of these plans, savers can invest in potentially high-return assets such as stock funds.

 

With the 403(b) and 401(k), your employer may provide matching funds if you contribute to the plan. The employer match can be a great incentive to save since it provides a strong risk-free return on your contributions, and experts routinely advise workers to claim all this “free money.” More 401(k) plans offer a match than do 403(b) plans, for legal reasons explained below.

For example, an employer might match 50% of your contribution up to 6% of your salary. So if you contribute 6% of your paycheck, your company will contribute another 3%, and you’ll effectively have saved 9%. But if you save 7% of your salary, the company will still contribute the same 3%, meaning you’ve saved a total of 10%.

If there’s a downside to matching, it’s that the funds have to vest, usually over a period of years.

Who can use 403(b) and 401(k) plans?

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