Retirement planning is an important part of any financial strategy, and understanding the available retirement savings options is a substantial step toward ensuring a financially secure future.
Two common retirement savings plans offered by employers, depending on who you work for, are 401(a) and 403(b) plans.
What’s the difference between 401(a) and 403(b)?
A 401(a) plan is typically established by government or non-profit employers, with contributions often mandatory and set by the employer, while a 403(b) plan is available to employees of tax-exempt organizations and public schools, with contributions usually made voluntarily by the employee.
The specific contribution limits, investment options, and distribution rules can vary between these two types of plans, but both offer tax-advantaged retirement savings.
While they share some similarities, they also have distinct features, eligibility requirements, and contribution rules. This article aims to differentiate these two types of plans, shedding light on their differences, benefits, and how they can fit into your retirement savings strategy.
Whether you’re a public sector employee, a non-profit worker, or simply someone interested in retirement planning, read on to gain valuable insights into 401(a) and 403(b) retirement plans.
Here’s a simple comparison table to illustrate the differences and similarities between 401(a) and 403(b) plans:
|Features||401(a) Plan||403(b) Plan|
|Plan Sponsorship||Typically offered by government and non-profit employers||Designed for employees of tax-exempt organizations, public schools, and certain ministers|
|Contributions||Contributions can be made by the employee, employer, or both. They are often mandatory and determined by the employer||Contributions are usually made by the employee on a voluntary basis, often through salary deferral. Some plans allow employer contributions|
|Investment Options||A range of investment options are usually available, including mutual funds||Historically offered annuity contracts, but most modern plans also offer mutual funds|
|Contribution Limits (2023)||Total annual contributions are limited to the lesser of 100% of the participant’s compensation or $66,000||Total annual contributions limited to the lesser of 100% of the participant’s compensation or $66,000. Additional “catch-up” contributions and “15-year rule” allowances may apply|
|Withdrawal and Distribution Rules||Withdrawals are allowed in certain cases such as retirement, termination of employment, disability, reaching age 59 1/2, death, or financial hardship||Similar to 401(a) plans, with withdrawals allowed under similar conditions|
The specifics of each plan can vary based on how the employer structures the plan, and IRS rules and contribution limits can change from year to year.
What Is a 401(a) Plan?
A 401(a) plan is a retirement savings plan often available to public sector employees and specific nonprofit organizations. The details of these plans are usually designed by the employer, including eligibility, contribution rates, and vesting schedules.
A 401(a) plan, also known as a money-purchase retirement savings plan, allows for both employee and employer contributions. The contributions made by both parties are defined by specific percentages of the employee’s salary, and these percentages are predetermined by the employer.
One key characteristic of 401(a) plans is their flexibility. Employers have significant leeway in customizing the plan’s features according to the organization’s goals and needs. They can determine the criteria for employee eligibility, set required or optional employee contributions, and decide whether the plan will consist of pre-tax, after-tax, or Roth contributions.
The contributions and any earnings in the 401(a) plan grow tax-deferred until retirement or withdrawal. When an employee retires or leaves the job, they have several options: They can roll the funds over into another qualified retirement plan, take a lump-sum distribution (which is subject to taxes), or, in some cases, annuitize the funds into a stream of regular income.
The IRS sets a limit on the total annual additions to a participant’s account. This limit is the lesser of 100% of the participant’s compensation or $66,000 in 2023 (this amount is subject to annual change with inflation adjustments). The limit includes employer contributions.
Distributions taken before age 59 1/2 are subject to a 10% early withdrawal penalty in addition to regular income tax. There are certain exceptions to this rule, such as distributions made due to disability, death, or under a series of substantially equal periodic payments.
401(a) plans are less common than 401(k) or 403(b) plans, but they are valuable tools for retirement savings in sectors where they are available.
As with all retirement savings plans, individuals should consider their options carefully, often with the help of a financial advisor, before making decisions about their contributions and investments.
What Is a 403(b) Plan?
A 403(b) plan is a type of tax-sheltered retirement plan that is very similar to a 401(k), but it’s specifically designed for certain employees of public schools, tax-exempt organizations, and certain ministers. The name “403(b)” comes from the section of the Internal Revenue Code where the plan’s rules are found.
Key features of a 403(b) plan include:
With a 403(b) plan, employees can elect to have part of their salaries put into the plan. These contributions are made pre-tax, which means they lower the employee’s taxable income for the year. As a result, taxes on both the initial contributions and the investment earnings are deferred until the funds are withdrawn at retirement.
Similar to other retirement plans, 403(b) plans allow for “catch-up” contributions for employees aged 50 and older. This means that these employees can contribute extra funds beyond the usual annual limit to boost their retirement savings.
Some employers will also make contributions to the 403(b) plans of their employees. These contributions can be in the form of a match (where the employer contributes the same amount as the employee up to a certain percentage) or nonelective contributions (where the employer contributes a set amount regardless of the employee’s contributions).
Employers can contribute a maximum additional amount of $43,500 in 2023, which brings the total contribution limit to $66,000.
Withdrawals and Loans
Withdrawals from a 403(b) plan are allowed when the employee reaches age 59½, leaves their job, becomes disabled, or encounters a financial hardship. Withdrawals are subject to income taxes at that time. Like other types of retirement plans, 403(b) plans may also allow loans to be taken out against the savings.
The maximum contribution limit for 403(b) plans in 2023 is $22,500, with an additional catch-up contribution of $7,500 allowed for those aged 50 or older.
Long-term employees may be eligible to contribute additional amounts beyond these limits under the “15-year rule,” which allows certain employees with 15 years of service to their current employer to contribute an additional $3,000 annually, up to a lifetime limit of $15,000.
A 403(b) plan is a valuable retirement savings vehicle for those who have access to it, providing a method for tax-deferred savings to help ensure financial stability in retirement.
What are the Tax Benefits of 401(a) Plans?
401(a) plans, like other qualified retirement plans, offer significant tax benefits as an incentive for individuals to save and invest for their retirement. These benefits include:
Contributions to a 401(a) plan, as well as any investment gains, grow tax-deferred. This means you don’t have to pay income tax on your retirement savings until you start withdrawing funds. This tax-deferred growth can result in a larger retirement nest egg over time compared to taxable accounts due to compounding growth on the funds that would have otherwise been paid in taxes.
Pre-Tax or After-Tax Contributions
Depending on the specifics of the plan, contributions may be made on a pre-tax, after-tax, or Roth basis. If made on a pre-tax basis, these contributions are taken out of your salary before taxes are deducted, which can reduce your current taxable income.
On the other hand, after-tax and Roth contributions are made with income that’s already been taxed, but the distributions (including earnings) from these contributions are tax-free at retirement if certain conditions are met.
If the employer makes matching contributions to your 401(a) account, these contributions are also tax-deferred. This means you don’t have to pay income taxes on these funds until you withdraw them in retirement.
Potential for Tax Diversification
If your plan allows both pre-tax and Roth contributions, you can decide to make either or both types of contributions. This can provide tax diversification, giving you the option to draw from taxable and potentially tax-free sources of income in retirement.
Although taking distributions from a 401(a) before the age of 59 1/2 typically results in a 10% early withdrawal penalty, there are exceptions. For instance, if you leave your job during or after the year you turn 55, you might be able to take penalty-free withdrawals.
If you leave your job, you can roll over your 401(a) funds into another qualified retirement plan or an IRA without incurring any tax penalties. This can help you maintain the tax-advantaged status of your retirement savings.
What are the Tax Benefits of 403(b) Plans?
403(b) plans offer several tax advantages to participants, which can make them an attractive vehicle for retirement savings. These benefits include:
Employee contributions to a 403(b) plan are typically made on a pre-tax basis. This means that the money is deducted from your salary before taxes are taken out, which can reduce your current taxable income.
The funds in a 403(b) plan grow tax-deferred. This means that you don’t pay taxes on any interest, dividends, or capital gains within the account until you start withdrawing funds in retirement.
Tax-deferred growth leads to a larger account balance over the long term compared to an equivalent taxable account, thanks to compounding on the funds that would have otherwise been paid in taxes.
Tax-Deductible Employer Contributions
If your employer contributes to your 403(b) plan, these contributions are also made with pre-tax dollars and grow tax-deferred.
Some 403(b) plans offer a Roth option. With Roth 403(b) contributions, you pay taxes on your contributions upfront, but your withdrawals in retirement, including any earnings, are generally tax-free, assuming you meet the necessary conditions (at least 59 1/2 years old and the Roth account has been held for at least 5 years).
Participants aged 50 and over can make additional catch-up contributions, which also grow tax-deferred. In addition, certain employees with 15 years of service may be eligible to make additional “special catch-up” contributions beyond the usual annual limit.
Penalty-Free Withdrawals in Certain Cases
While withdrawals from a 403(b) prior to age 59 1/2 generally incur a 10% early withdrawal penalty, certain exceptions exist. For instance, distributions made due to disability, financial hardship, or as part of a series of substantially equal payments over your life expectancy are exempt from the early withdrawal penalty.
If you leave your job, you can typically roll over your 403(b) funds into another qualified retirement plan or an IRA without triggering taxes or penalties, preserving the tax-advantaged status of those funds.
401(a) vs. 403(b): Contribution Limits and Rules
401(a) and 403(b) retirement plans have several similarities, but they also have key differences, particularly when it comes to contribution limits and rules.
401(a) Contribution Limits and Rules
- The IRS doesn’t set a specific contribution limit for 401(a) plans. Instead, it sets a limit on the total annual additions to a participant’s account. As of 2023, this limit is the lesser of 100% of the participant’s compensation, or $66,000. This amount is adjusted periodically for inflation. This includes both employee and employer contributions.
- The specifics of contributions, such as whether they are mandatory or voluntary and the contribution amount, are determined by the employer.
- If the plan allows, employees may make either pre-tax, after-tax, or Roth contributions.
403(b) Contribution Limits and Rules
- As of 2023, the maximum contribution limit for 403(b) plans is $22,500 for those under the age of 50. Employees aged 50 or older can make an additional catch-up contribution of $7,500, bringing their total potential contribution to $30,000.
- Long-term employees (with 15 years of service) may be eligible to contribute up to $3,000 extra per year under the “15-year rule,” up to a lifetime limit of $15,000. This is a unique feature of 403(b) plans not generally available in 401(a) plans.
- The total annual additions to a 403(b) plan (including employee contributions, employer matching contributions, and forfeitures) cannot exceed the lesser of $66,000 (for 2023) or 100% of the employee’s most recent yearly salary.
- Typically, contributions to a 403(b) plan are made by the employee on a pre-tax basis, though Roth contributions are allowed if the plan offers a Roth option.
In both cases, withdrawing funds before the age of 59½ will typically incur a 10% early withdrawal penalty, in addition to regular income taxes, unless a specific exception applies. Both types of plans also allow for tax-free rollovers into other retirement accounts.
The IRS typically adjusts contribution limits and income thresholds annually to account for inflation. Check the most recent IRS guidelines or consult with a financial advisor to understand the current rules and limits.
401(a) vs. 403(b): Investment Options
Investment options in both 401(a) and 403(b) plans can vary widely depending on the specifics of the plan, the plan provider, and the choices made by the employer. Here’s a general overview:
401(a) Investment Options
401(a) plans typically offer a broad array of investment options. The specifics depend on how the employer has structured the plan, but options often include a range of mutual funds encompassing different asset classes (stocks, bonds, money market instruments), target-date funds (which automatically adjust the investment mix based on a chosen retirement date), and sometimes individual stocks and bonds.
The employer or plan administrator typically chooses the specific investment options available within the plan, and participants can choose how to allocate their contributions among these options.
403(b) Investment Options
Historically, 403(b) plans were limited to annuity contracts provided by insurance companies. However, over time, the law has changed to allow 403(b) plans to also include mutual funds within a custodial account.
Today, many 403(b) plans offer a range of mutual funds similar to those found in 401(a) plans, including equity funds, bond funds, balanced funds, and target-date funds.
However, some 403(b) plans, particularly those at smaller organizations or in certain sectors, may still be heavily weighted towards annuity products.
While these can provide a steady income stream in retirement, they might not be the best fit for all investors due to their fees, surrender charges, and other factors.
As with 401(a) plans, the specific investment options in a 403(b) plan are usually chosen by the employer or plan administrator, and participants can choose how to allocate their contributions among these options.
In both types of plans, it’s necessary for participants to understand their investment options and make choices that align with their risk tolerance, investment goals, and time horizon.
401(a) vs. 403(b): Withdrawals and Distributions
Both 401(a) and 403(b) plans have specific rules and regulations when it comes to withdrawals and distributions.
401(a) Withdrawals and Distributions
Withdrawals from a 401(a) plan can typically be made under the following circumstances:
1. Retirement or termination of employment
2. Death (benefits go to a designated beneficiary)
4. Reaching age 59½
5. Financial hardship (if the plan allows for hardship withdrawals)
Like most retirement plans, early withdrawals (before age 59½) are generally subject to income taxes and a 10% early withdrawal penalty unless a specific exception applies.
In addition, once you reach age 72 (or age 70½ if you reached 70½ before January 1, 2020), you must begin taking required minimum distributions (RMDs) from your 401(a) plan, unless you’re still working for the employer that sponsors the plan and you don’t own more than 5% of the company.
403(b) Withdrawals and Distributions
The rules for withdrawals from a 403(b) plan are similar to those for a 401(a). Withdrawals can generally be made under the following circumstances:
1. Retirement or termination of employment
2. Death (benefits go to a designated beneficiary)
4. Reaching age 59½
5. Financial hardship (if the plan allows for hardship withdrawals)
Again, early withdrawals are typically subject to income taxes and a 10% early withdrawal penalty unless a specific exception applies.
As with a 401(a), once you reach age 73, you generally must begin taking required minimum distributions (RMDs) from your 403(b) plan unless you’re still working for the employer that sponsors the plan and you don’t own more than 5% of the company.
In both cases, how the distributions are taxed depends on whether the contributions were made pre-tax or after-tax. Pre-tax contributions and any earnings are generally taxed as ordinary income when withdrawn, while qualified distributions from after-tax or Roth contributions are typically tax-free.
Can You Contribute to a 401(a) and a 403(b)?
A person is allowed to contribute to both a 401(a) and a 403(b) plan if you have access to both types of plans through your employment.
The specific rules and limits for contributing to multiple retirement plans can be complex and depend on the exact types of plans involved. The IRS has rules to prevent “double-dipping” of tax advantages, but these rules typically apply to contributing to two of the same type of plan, or to a combination of plans where the total contribution limit is shared across the plans (for instance, a 403(b) and a 401(k)).
However, 401(a) and 403(b) plans each have separate contribution limits. This means you can contribute up to the maximum allowed limit for each plan, effectively increasing the total amount you can contribute to retirement accounts in a given year.
The specific rules and contribution limits can change from year to year and can be affected by your income and other factors, so it’s always a good idea to consult with a financial advisor or tax professional to understand how these rules apply to your specific situation.
Summary Of The Differences Between a 401(a) and a 403(b)?
401(a) and 403(b) plans are both tax-advantaged retirement savings plans offered by employers. They share some common features, such as the ability to grow investments on a tax-deferred basis and to receive employer contributions.
However, there are key differences between the two types of plans, including who they’re designed for, how contributions are made, and what investment options are available.
1. Plan Sponsorship
- A 401(a) plan is usually established by a government or non-profit employer, including state and local government entities, educational institutions, and churches. These employers set the plan’s rules, including eligibility criteria, contribution amounts, and investment options.
- A 403(b) plan is specifically for employees of tax-exempt organizations, public schools, and certain ministers. This includes employees of public education institutions (K-12 and higher education), certain non-profits, cooperative hospital service organizations, and self-employed ministers.
- In a 401(a) plan, contributions are often mandatory and determined by the employer. Contributions can be made by the employee, the employer, or both, and may be a fixed amount, a matching contribution, or a percentage of salary.
- In a 403(b) plan, contributions are usually made by the employee on a voluntary basis, often through salary deferral. Some 403(b) plans also allow for employer contributions.
3. Investment Options
- 401(a) plans often offer a range of investment options, including mutual funds that invest in stocks, bonds, and other assets. The specific options depend on the plan’s structure and the choices made by the employer or plan administrator.
- Historically, 403(b) plans were limited to annuity contracts. However, most modern 403(b) plans also offer mutual funds. Some 403(b) plans, particularly those at smaller organizations or certain sectors, might still heavily feature annuity products.
4. Contribution Limits
- For both 401(a) and 403(b) plans, the total contribution limit (as of 2023) is the lesser of 100% of the participant’s compensation or $66,000. However, 403(b) plans have an additional “catch-up” contribution limit of $7,500 for participants aged 50 and older and a “15-year rule” that allows certain long-term employees to contribute an extra $3,000 annually, up to a lifetime limit of $15,000. These specific “catch-up” features are not generally available in 401(a) plans.
5. Withdrawal and Distribution Rules
- Both 401(a) and 403(b) plans have similar rules for when withdrawals can be made (e.g., retirement, termination of employment, reaching age 59 1/2, in case of disability or death, or financial hardship). Early withdrawals are typically subject to income taxes and a 10% penalty unless an exception applies.
401(a) and 403(b) plans both offer unique opportunities for retirement savings. They provide tax advantages that can help your savings grow more efficiently over time.
While they have distinct features, the choice between a 401(a) and a 403(b) will often depend on your specific employment situation, as these plans are typically offered by different types of employers.
As with any financial decision, you must understand your options and consider your personal financial goals, risk tolerance, and retirement horizon.
One last time: It’s always a good idea to consult with a financial advisor or tax professional to fully understand the implications of participating in these plans and to make the choices that best fit your individual needs and circumstances.