What is the difference? – Forbes Advisor

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Employers offer 403(b) and 401(k) plans to help their employees save for retirement, but you probably won’t have to choose between them. These two tax-advantaged retirement plans are designed for different types of businesses: 403(b) plans are for non-profit organizations and certain government employers, while 401(k) plans are offered by corporations. profit.

What is a 401(k)?

Most for-profit companies offer 401(k)s, which help their employees build tax-efficient retirement savings. Depending on whether you choose a traditional or Roth 401(k)contributions to the plan are deducted from your salary before or after tax.

With a traditional 401(k), your contributions to the plan are deducted from your pay before income tax, which lowers your taxable income today. You pay taxes on withdrawals from your 401(k) account when you retire. If you choose a Roth 401(k), you pay taxes on your contributions to the plan today and you owe no tax on withdrawals in retirement.

In both types of plans, your money grows tax-free and investment gains are not subject to capital gains taxes. If you need to withdraw funds before retirement age (currently 59.5), you generally owe a 10% penalty plus income tax on any money not yet taxed.

To grow your money, 401(k)s allow you to invest primarily in mutual fund. You can choose a combination of stock and bond funds, depending on how aggressively you want to invest. You can also select a target date fundwhich invests you in a range of other funds that go from aggressive to conservative until you retire.

401(k) correspondence

To encourage you to save for your retirement, most employers make their own contributions to your 401(k) account. These can be in the form of mismatch and matching contributions.

Unmatched contributions require no further action on your part. Your employer simply deposits a lump sum or percentage of your salary into your 401(k) account.

With matching contributions, your employer agrees to invest up to a certain percentage of your salary based on what you contribute to the plan. For example, an employer may offer 100% match on up to 3% of your earnings. If you were making $60,000 a year, that means your employer would pay out up to $1,800 a year of what you invest in your 401(k).

With 401(k) matches, you need to pay attention to all vesting requirements. These are restrictions your employer places on the money they contribute to your 401(k). For example, your employer may say that you only own more than 20% of what they invest in your account for each year you work there until you own 100% at five years. If you leave before your vesting is complete, you’ll only take a portion of what your employer contributed to your 401(k).

401(k) contribution limits

Due to the tax advantages offered by the 401(k), the government sets contribution limits on how much you can save in your 401(k) each year.

For 2022, the maximum you can contribute is $20,500. If you are 50 or older, you are entitled to catch-up contributions of an additional $6,500 per year.

The contribution limit does not include employer contributions. The total annual contribution limit for 2022, including your contributions and those of your employer, is the lesser of your annual salary or $61,000 ($67,500 if you are eligible for catch-up contributions).

What is a 403(b)?

403(b) plans are tax-deferred retirement accounts for schools and universities, churches, and nonprofit organizations. As with 401(k) plans, you can choose to save in a traditional 403(b) and a Roth 403(b), depending on whether you want tax relief now or in retirement.

With a traditional 403(b), you now deduct contributions from your taxable income and pay taxes on retirement withdrawals. With a Roth 403(b), you pay income taxes now and aren’t taxed in retirement.

Either way, contributions grow tax-free while they’re in the account, and you’ll usually have to pay taxes on money that wasn’t previously taxed, plus a 10% penalty. , on withdrawals before age 59.5. 403(b) contributions can generally be invested in mutual funds or annuities, although these options are normally more limited than those of 401(k).

Employer contributions are possible with 403(b) accounts, although they are less common than with 401(k) accounts because employers must comply with the Employee Retirement Income Security Act (ERISA). These regulations set strict minimum standards for employer-sponsored pension plans, and many nonprofits are opting out of ERISA and the employer contributions it allows.

If your employer complies with ERISA and offers 403(b) employer contributions, you may face a vesting period. This, however, is normally shorter than 401(k) vesting periods.

403(b) Contribution limits

403(b) plans have the same contribution limits as 401(k) plans. In 2022, you can contribute up to $20,500 per year to your 403(b). If you are 50 or older, you can contribute an additional $6,500 per year.

If your employer contributes to your 403(b), the maximum amount that can be contributed to your 403(b) in 2022, including your contributions, is the lesser of 100% of your salary or $61,000 per year (67 $500 if you are 50 or older).

While 401(k) and 403(b) plans have the same general contribution limits, 403(b) accounts have an advantage: employees who have worked for a qualified organization for 15 years or more may be eligible to make additional contributions. Eligible employees can contribute up to $3,000 per year for five years above the federal maximum.

401(k) vs. 403(b): which is better?

Because the type of retirement plan you qualify for depends on your employer, you generally don’t have the choice of saving for your retirement with a 403(b) or 401(k) plan.

No matter what type of plan you have access to, the important thing is to take advantage of it and contribute to it regularly. Most experts recommend investing most of your retirement savings in a mix of diverse, low-cost investments. index funds or a target date fund that does it automatically for you. You can probably find these types of investments in a 403(b) or 401(k).

In the very rare case where you might be lucky enough to have access to both a 403(b) and a 401(k), keep a few things in mind:

“In a 401(k), you can invest in individual stocks, bonds, mutual funds and ETFs. In a 403(b) plan, you are limited to investing in mutual funds and annuities says Ed Canty, a certified financial planner (PCP). And since the passage of the SECURE Act of 2019, you can now invest in certain annuities in 401(k) plans, which means “if you had a choice between the two accounts, the 401(k) offers a little more flexibility for investment vehicles”.

Also remember that if you contribute to more than one type of plan in the same year, you have the same annual employee contribution limit for all of them. “That means you can contribute to both a 403(b) and a 401(k), but your combined total contributions can’t exceed $19,500” or $24,500 if you’re 50 or older, explains Canty.

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