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

In many practical respects, participants won’t notice much of a difference between 403(b) plans and 401(k) plans, but technical legal differences do still affect the plans. Here are the key ones:

—403(b) plans are not subject to nondiscrimination testing: Unlike firms with 401(k)s, those with a 403(b) can avoid annual testing that evaluates whether highly compensated employees are getting too much benefit from the retirement plan, relative to low earners. However, this “perk” disappears if the company offers an employer match.

—Many 403(b) plans don’t offer an employer match: Because employers with a 403(b) are disincentivized to offer a match, they may not do so, to avoid annual testing.

—Investment options can differ markedly: Many 403(b)s may have a narrower selection of investments, focusing on annuities, while 401(k)s may offer more mutual funds and allow the purchase of individual stocks and bonds as well as annuities. Historically, the 403(b) has been run by insurance companies, while fund companies have run 401(k)s.

Despite these differences, the workers participating in these plans may not otherwise notice.

Is a 403(b) plan better than a 401(k) plan?

In most respects 403(b) plans 401(k) plans offer the same benefits, whether that’s the ability to save for retirement in a pre-tax or after-tax account, invest in potentially high-return assets, amass wealth tax-deferred or tax-free and enjoy an employer match on contributions.

However, if there’s a practical difference, many employers offering a 403(b) plan may opt to not offer an employer match because of legal complications surrounding those who offer a match. The lack of a match may make the 403(b) much less attractive as a retirement account.

A 401(k) plan may also offer more investment choices, particularly with regard to potentially high-return investments such as mutual funds, while 403(b)s may offer a narrower selection. But the exact investment selection depends heavily on the company and the plan’s administrator.

Finally, what most distinguishes the 403(b) plan from the 401(k) plan is who has access to each plan. The 403(b) is for school districts, churches, charities and some public-sector employees.

In contrast, the 401(k) is for private-sector employees, such as those working at private firms.

Bottom line

Both 403(b) and 401(k) plans allow workers to save for retirement in a tax-advantaged account. Key differences include which companies can use each type of plan, the investment selection and regulations surrounding nondiscrimination testing and its effects on employer matches.