When you’re looking at retirement plans in the United States, you will find that many numbers are thrown at you. These numbers are based on the tax code which oversees each plan, as most have certain tax advantages which come with them.
Two popular retirement plan options are the 401a and 403b retirement plans.
In the 401a vs 403b debate, you will find that these two plans are extremely similar. The only primary difference between the two, in fact, is who is permitted to sign up for each of them.
In-Depth with the 401a Retirement Plan
The IRS uses Section 401 of the tax code to define specific types of investment and retirement accounts. It is the same section that is used to define the 401k plans that are often offered as an employee benefit. The (a) designation separates it from all other types of plans within the same section.
With the 401a retirement plan, both employees and employers are permitted to make contributions to the plan. These contributions may be simultaneous. Contributions can be made to the retirement plan before calculating the amount of taxes that are owed by the employee for income earned.
That creates a lower level of taxable income for the employee, which helps them save a little on their income taxes each year.
Then account holders with a 401a retirement plan are permitted to use their funds to invest into certain securities, such as stocks or bonds. When the account holder retires, then the money withdrawn from the account will be taxed as income because the funds went into the account before taxes were withheld from the amount.
The goal of the 401a plan is to encourage employees to put some money away from their retirement. To prevent an early withdrawal, there is a 10% tax penalty that must be paid, in addition to the standard income tax that is required on the amount.
There are some exceptions, such as an unexpected medical cost or a disability, that permit an early withdrawal without the tax penalty.
Because of the structure of this plan, some employees may find that they have the option to either contribute to a 401a plan or to a traditional pension, especially if they are a government employee.
In-Depth with the 403b Retirement Plan
The IRS uses Section 403 of the tax code to define certain types of investment and retirement accounts as well. The only difference here is that a 403b retirement plan is intended for use by employees who work for a non-profit organization in the United States. Some tax-exempt organizations qualify for this plan as well.
Employees of the public school systems in each community, religious organizations, and community service organizations are those who are the most likely to be saving their money in a 403b retirement account.
The same rules which apply to the 401a retirement plan are in effect with the 403b plan. Employees and employers are permitted to make simultaneous contributions to the plan. These contributions occur before taxes are withheld from the income.
Account holders with a 403b are also subject to the same 10% tax penalty for an early withdrawal. You are also given the same tax advantages with this retirement plan when compared to the 401a.
What Are the Contribution Limits of the 401a and 403b Retirement Plans?
Unlike the 401k, which offers a normal limit of $18,500 in the 2018 tax year, the 401a plan permits contributions up to $55,000 per year to be made to the plan. For most people, however, there is a set contribution from the employee and the employer that goes into this plan.
According to IRS rules, it is not permitted to contribute more to the plan than what the employee earns in salary from the employer. That means a worker earning $34,000 per year is permitted a maximum $34,000 contribution to their 401a plan.
With a 403b plan, there is a limit to the number of elective deferrals permitted. Employees in 2018 are allowed to contribute $18,500 to their retirement plan during the calendar year. Employees who are above the age of 50 are also permitted to make a catch-up contribution of $6,000 beyond the basic limits.
There is also a limit on the annual additions permitted with a 403b retirement plan, which is the combination of all employer contributions and elective deferrals by the employee. This limit is the same as it is for the 401a plan, capped at $55,000 for the year in 2017. If you make less than that in salary, then your salary becomes the maximum contribution permitted with both combined.
The retirement age for the 401a and 403b retirement plans is 59.5. Withdrawing money from the retirement plan incurs a tax penalty unless it is for a qualifying reason. Any early withdrawals are subject to the 10% additional tax. You must also begin taking a minimum distribution from the retirement plan when you reach the age of 70.5.
The Flexibility of the 401a Retirement Plan
There are several different ways that a 401a retirement plan can be implemented in the workplace. The most common method is to take a percentage of an employee’s pay and place it into the plan. Aside from agreeing to the percentage taken, no other work needs to be done by the employee. You can decide to change the percentage withdrawn for the retirement plan at a designated point during the year.
A 401a may also be created with an employee required to pay a specific percentage to the plan without exception. This lowers the employee’s salary for take-home pay, but increases the amount saved in the retirement plan.
Another variation of the 401a is that an employee can be asked to contribute a percentage of pay before taxes, but this is a one-time choice. If you decide not to participate in the 401a plan offered at the time, then you are excluded from future participation. If you do decide to participate, then the contribution percentage you choose is locked in permanently.
A final variation, but one that is rarely offered in the United States, is similar to a Roth retirement savings plan. Instead of using pre-tax dollars to contribute to the 401a, you would use after-tax money. In this plan, you can start, stop, or change the amount you contribute at any time. The advantage of this plan is that your earnings are taxable, but the contributions are not taxed when you withdrawal at retirement.
The Catch-Up Exception for the 403b Retirement Plan
There is one unique benefit which comes with the 403b retirement plan that you don’t receive with the 401a plan. With the 403b, you’re permitted to have a special catch-up contribution if you have 15 years of verifiable service to a specific employer. The employer must be a hospital, home health service organization, religious institution, health and welfare service agency, or public school.
In this situation, you can have your 403b elective deferral limit increased by the lesser of the following.
- $15,000, which is reduced by the amount of additional elective deferrals made in prior years with this rule in place.
- $5,000 multiplied by the number of years of service provided by the employee, less the total elective deferrals made for earlier years.
Under the 15-year catch-up rule exception, the elective deferral maximum is $21,000. Employees above the age or 50 who qualify for the age-based catch-up may also be permitted to contribute the extra $6,000 in contributions for 2018.
For those who apply for both catch-up circumstances, the IRS requires that the first deferrals which exceed the $18,500 standard limit be applied to the 15-year catch-up contribution first, whenever permitted, Then the age 50+ catch-up contributions are permitted.
If you have a 403b retirement plan and make contributions to other plans, excluding the 457 plan, then all contributions must be combined together. You are not permitted to contribute $18,500 to a 403b, then another $18,500 to a 401k, SIMPLE IRA, or similar qualified plan.
A Final Word on 401a and 403b Retirement Plans
Knowing which plan you qualify for with your employer will help you be able to make the right decision about your contributions. Both plans are very similar in structure, with only a few exceptions separating the two.
Each plan allows you to save for retirement. Each gives you choices in how you can grow your wealth, with specific contribution caps in place that you must consider. Over time, and with the catch-up contributions allowed, you can use this tool to effectively save for the future years to come.