If you’re an employee whose company offers a 403(b) plan, it’s important to understand the difference between it and a 401(k) plan. Generally, nonprofit organizations such as schools and hospitals offer 403(b)s, though they may offer 401(k)s as well. For-profit companies may offer 401(k)s, but they are not allowed to offer 403(b)s.
The similarities between 403(b)s and 401(k)s
Both 403(b)s and 401(k)s are retirement accounts with similar annual contribution limits. The elective deferral limit for 2015 is $18,000, and you may contribute an additional $6,000 in “catch-up” contributions if you’re 50 or over.
For both 403(b)s and 401(k)s, the limit on total annual contributions—your deferrals and your employer’s contributions—can’t exceed $53,000 in 2015.
Additionally, both plans can have a Roth option. If you have this option, you can designate all or part of your contribution to go toward a Roth account. Unlike a traditional 401(k) or 403(b), where you contribute pre-tax money and pay taxes when you withdraw the money, the money you contribute to a designated Roth account is after-tax. You’ll pay taxes on your contributions, but you won’t pay taxes when you withdraw the earnings.
(Read more: Retirement investing tips for young investors)
Depending on the plan administrator’s rules, you may borrow up to 50 percent of the balance of the account, or up to $50,000, whichever is less. Some administrators only allow loans in the case of emergencies or home purchases, while others don’t allow any loans. When they are available, however, these loans can provide you with funds at a very low interest rate. You won’t pay taxes on the draws, but think carefully before you decide to dip into your retirement funds.
Finally, with both a 401(k) and 403(b), an employer may match all or part of your contributions.
The differences between 403(b)s and 401(k)s
Because 403(b)s are offered by organizations such as schools, hospitals, or religious groups, your employer may not have the funds to match your retirement contributions the way a for-profit employer would match your 401(k) contributions.
Additionally, the 403(b) offers a more limited array of choices for investing your contributions (though there are more options available now than in the past). These typically include a number of annuities, including fixed annuities, equity-indexed annuities, and variable annuities, as well as mutual funds. Annuities are contracts with insurance companies wherein you make one large deposit or a series of deposits in return for regular payments at a later date.
If you’re self-employed, you may set up a 401(k) and contribute 20 percent of your net profits, up to a $52,000 limit. (The IRS says you may contribute up to 25 percent, but that’s before adjustments. The net turns out to be only 20 percent.) If you own a profitable business with your spouse, you may each fund your own account up to that limit, allowing you to save more than $100,000 annually for retirement. These contributions don’t reduce the profits you report on Schedule C, which is great news if you’re trying to show potential lenders your business’s profitability.
If you’re self-employed, you may not set up a 403(b) plan.
Tips for maximizing your retirement plan
When it comes to your employer’s retirement plan, in all cases, contribute as much as you can possibly afford. When the money comes out of your paycheck before you see it, you don’t miss it. You simply spend less on impulse shopping.
Do your best to meet your annual contribution limit each year. In addition to building your retirement savings, you can get a federal and state income tax deduction for your contribution to your 401(k) or 403(b). You can also choose to waive the deduction and contribute to a Roth 401(k) or 403(b) option, if it’s available.
All in all, it’s never a bad idea to build up savings. In times of trouble, that money is there to help you.
Eva Rosenberg, EA is the publisher of TaxMama.com®, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches terrific courses that might help individuals and small businesses at CPE Link.