Saving for retirement can seem daunting for those looking into the various types of tax-advantaged savings accounts. Many people have access to a 401(k) account through their employer, but some may also have access to a 403(b) account through a non-profit or government entity. One of the most popular questions asked by those with access to both types of investments is, "can I have both?"
You are able to have both a 403(b) & 401(k), as well as make contributions to both. The catch is that you will need to pay close attention to how much you are contributing to each. You will only be allowed to contribute a combined total of $20,500 between both.
Even though this seems straightforward, there are a number of things to consider before contributing the maximum amount possible. There are significant differences between the two types of accounts, and while different employers may offer them, they can be used in different ways. We're going to look at both types of retirement funds, the differences between the two, as well as the smartest ways to contribute to each or both if you have access.
What Is A 403(b) vs. 401(k)?
Most people have at least a basic understanding of a 401(k), but there are many that haven't ever heard of a 403(b). Let's take a look at what they are and how they each operate.
What Is A 401(k)?
A majority of for-profit companies that offer retirement plans offer their employees access to a 401(k). The primary goal of the 401(k) is to apply contributions to a tax-advantaged savings account. Whether it is a Roth 401(k) or a traditional 401(k), the employee can make contributions both pre-tax and after-tax income.
A traditional 401(k) generally has the employee make contributions from their pre-tax income. Not only does that allow them to save a portion of their income in a tax-advantaged account, but it also helps reduce their overall taxable income. Since the taxes on 401(k) withdrawals are only paid once you are in retirement, this is a great idea for those who feel that taxes are going to be lower in the future. A similar process occurs with a Roth 401(k), except instead of focusing on pre-tax income, the Roth plan takes contributions from after-tax income, with the end result being that the retirement withdrawals remain untaxed.
With both the traditional and the Roth 401(k), you are able to save easily and often automatically, while you also help your money grow in a tax-free environment. They are incredibly popular since the interest and investment gains from a 401(k) are not subject to the often significant capital gains taxes. This can change, however, if you choose to withdraw any funds early. Withdrawals made before the official retirement age of 59 ½ will then be subject to a 10% early withdrawal penalty as well as income taxes on any funds that haven't already been taxed.
Another great feature that you should be on the lookout for when it comes to 401(k) plans is whether or not the employer offers a matching program, non-matching program, or even both. Non-matching programs are incredibly easy and helpful since they are a contribution that requires nothing from you in return. Your employer will simply make a contribution of either a percentage of your salary or, alternatively, a specific lump sum to your 401(k).
Matching contributions are where your employer commits to contribute based on your contributions. A common way to match, for example, is to match 100% of your contributions, up to 5% of your yearly pay. This means if you make $50,000 and contribute 5% or $2,500, your employer would also contribute $2,500. In cases where your employer will match, not making contributions is essentially ignoring free money.
The only catch to matching is that different employers will have different vesting requirements. This means if you leave before you're fully vested, you will only be able to take a portion of your matched contributions with you. Matching from some employers will be fully vested immediately, while some may only give you 20%-50% ownership each year until fully vested.
What Is A 403(b)?
A 403(b) plan is a tax-deferred savings account that is used by non-profit organizations like schools, churches, and other non-profits. Just like with a 401(k), you can choose whether you want your tax break now or when you retire, allowing you to choose between a conventional 403(b), or a Roth 403(b).
A traditional 403(b) will have contributions made from taxable pay now, leading to tax payments on withdrawal. A Roth 403(b) will allow you to pay taxes now, making your retirement income tax-free. You simply need to think about whether you feel taxes are going to be higher or lower in the future.
With both types of 403(b), your savings are allowed to grow, accumulate interest, and create investment returns, all tax-free. Similar early withdrawal penalties will apply to 403(b) withdrawals that are taken before the age of 59 ½.
When making contributions to a 403(b), you will have an opportunity to invest your contributions, but the options will generally be more limited than a 401(k). The funds in a 403(b) can often be invested in annuities or mutual funds, but the greater flexibility of investment is firm with the 401(k).
Difference Between 401(k) And 403(b)
The differences between a 403(b) and 401(k) plan lie primarily in their investment ability and versatility, their contribution limits, and their legal differences.
A 401(k) plan is able to invest in just about anything that can be traded through a conventional brokerage. They can have a mix of bonds, mutual funds, ETFs, some annuities, and even individual company stocks. A 403(b) plan will only allow you to invest in annuities and mutual funds, which can be limiting. The SECURE Act of 2019 removed many of the investment barriers for 401(k) plans, giving them access to even more options.
Legally, 403(b) plans do not have to abide by many of the rules set forth by the Employee Retirement Income Security Act, particularly if the employer does not contribute. This exemption from ERISA is lost when the employer participates in a matching program or other contribution to the employee's fund.
401(k) Contribution Limits 2022
While 401(k) funds seem like a great way to save as much money as possible for retirement without taxes playing a huge role, there are some limits. Since they are tax-advantaged and allow contributions from pre-tax income, the government has set limits on how much can be contributed each year.
For 2022, the maximum employee contribution is $20,500 per year for those under 50. If the employee is 50 or older, they are permitted to make additional "catch-up" contributions of $6,500 each year.
Most will see contribution limits as a bad thing, but there is a loophole that can give you a significant boost to your savings. The government-imposed contribution limits do not include contributions or matching programs from your employer.
If your employer has a 401(k) matching program, the total annual contribution limit for both parties combined becomes either $61,000 or your annual salary or earnings, whichever is lesser. Those age 50 and older have a combined limit of $67,500 per year to allow for catch-up contributions.
How Much Can You Contribute To 403(b)
Your 403(b) plan will have the same contribution limits as any 401(k) plan. You'll be able to contribute $20,500 per year unless you are 50 or older, in which case you can contribute $27,000 per year to catch up. If your employer makes matching or non-matching contributions to your 403(b), you are still only permitted to have a combined contribution of either an amount equal to your yearly pay, or $61,000 ($67,500 for >50), whichever is less.
Additionally, your employee contribution limit may change in the future, with up to $3,000 in additional contributions becoming possible. Generally, this happens once you have worked for the organization for 10-15 years or more.
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Understanding Your 403(b) & 401(k) Can Make Saving For Retirement More Effective
While 403(b) and 401(k) funds seem similar, they do have some notable differences that are worth remembering. Not the least among these differences is the employer contribution rules and the potential contribution limits. Being aware of these key differences and knowing when you can and can't contribute to both types of funds is vital for maintaining a solid retirement plan and savings. The most important thing to remember is that no matter which type you have, make sure you actually use it. Otherwise, you're leaving considerable amounts of money on the table.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.