When 403(b)s Are Not Just Like 401(k)s

For the most part, you can think of your 403(b) retirement plan as a 401(k). The similarities dramatically outweigh the differences.

Both are retirement plans offered only by an employer. They both offer a $23,000 employee contribution (for those under 50 in 2024) and a $69,000 total contribution (for those under 50 in 2024). They both can be enjoyed in tax-deferred and Roth flavors. The age 55 rule (not the age 59 1/2 rule) applies to both. If you leave the employer, you can access both 401(k) and 403(b) funds after age 55 without penalty. Both plans allow you to select your own investments from among those offered by the plan. They can both be rolled over into another employer retirement plan or an IRA when you separate from the employer. The balance in both of them does not affect the Roth conversion pro-rata rule. Required Minimum Distributions (RMDs) must be taken from both of them in retirement (although under Secure Act 2.0, those can be started as late as age 75). Both plans can offer an employer match. It's even theoretically possible (although rare) to do a Mega Backdoor Roth IRA with a 403(b).

While a public employee (teacher, university doc, etc.) is much more likely to be offered a 403(b) (plus a 457(b) and even a 401(a)) than a non-public employee, retirement investors and their advisors, for the most part, treat these accounts as equivalent. That's probably fine.

However, there are some subtle differences between the two, and this post is going to explore them.

#1 Catch-Up Contributions

Both 401(k)s and 403(b)s enjoy the age 50+ “catch-up contribution” of $7,500 (2024). However, 403(b) plans can (but are not required to) offer a second type of catch-up contribution—the “15 years of service catch-up contribution.” If you have been working for the employer for 15 years AND the plan allows it, your “elective deferral limit” (employee contribution) can be increased by the lesser of

1. $3,000,
2. $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or
3. $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

Complicated, I know. But the point is it is different. Most people are only going to get $3,000 a year ($15,000 total). That may not be much, but it beats a kick in the teeth. Note that 457(b) catch-up contribution rules are even stranger.

#2 Interactions with 401(a)s

If your employer offers a 401(k) and a 401(a), both plans share the same 415(c) (total contribution) limit ($69,000 in 2024). However, if your employer offers a 403(b) and a 401(a), both plans have their own 415(c) limit, totaling $138,000 in 2024).

#3 Interactions with Individual 401(k)s

If your employer offers a 403(b) and you have a side gig with an individual 401(k), those two plans share the same 415(c) limit ($69,000 in 2024). If you have multiple 403(b)s at multiple employers, they all share the same 415(c) limit. However, if the employer offers a 401(k) and you have an individual 401(k) for your 1099/independent contractor work, those two plans have their own separate 415(c) limits. If this is news to you, read the WCI classic post Multiple 401(k) Rules.

#4 403(b) Contributions Can Be Mandatory

Occasionally, I have run into a doctor whose 403(b) plan has mandatory contributions. I don't think 401(k) contributions are ever mandatory.

[FOUNDER'S NOTE BY DR. JIM DAHLE: Turns out I was wrong. See the comments for a doc with a mandatory contribution 401(k).]

#5 No Brokerage Window

401(k) investments generally consist of mutual funds, but they can also consist of stocks, bonds, ETFs, and annuities. In fact, 401(k)s can offer a “brokerage window” or even a “self-directed” feature that allows you to invest in almost anything. 403(b)s generally offer mutual funds and annuities. Until writing this post, I'd never seen one with a brokerage window, and I'd never heard of a self-directed 403(b). Apparently, a “master custodial account” that works similarly to a brokerage window can be made available in a plan, but the participant can still only purchase mutual funds and annuities with it. Interestingly, that rule does not apply to church 403(b)s.

The point is that you should expect more limited investment choices in a 403(b).

[FOUNDER'S NOTE BY DR. JIM DAHLE: After publication, I learned that at least two WCIers have a 403(b) with a brokerage window (see comments below), and one somehow allows them to buy individual stocks if they wish. Still, while every plan is unique, in general you're less likely to have as many investing options in a 403(b) than a 401(k).]

#6 Much More Likely to Be Offered Annuities

While a 401(k) can offer annuities as investment choices, it would be very unusual. That is not the case for 403(b)s. Fixed annuities, variable annuities, and even index-linked annuities (NOT the same thing as index funds) are frequently offered in 403(b)s. In fact, some 403(b)s ONLY offer annuities as investment options. 403(b)s are actually called Tax Sheltered Annuity Plans by the IRS.

#7 ERISA May Not Apply

The Employee Retirement Income Security Act of 1974 (ERISA) provides certain protections to retirement plans and their owners. These include such things as:

• Require plans to give participants information about the plan
• Sets minimum standards for participation, vesting, benefit accrual, and funding.
• Requires accountability of plan fiduciaries (including the company itself and the plan advisors)
• Gives participants the right to sue for benefits and fiduciary breaches
• Establishes the Pension Benefit Guaranty Corporation to guarantee certain benefits if a plan is terminated
• A federal level of asset protection law that generally exempts your retirement accounts from creditors if you have to declare bankruptcy

All 401(k)s fall under ERISA. However, 403(b)s may not fall under ERISA law if your employer does not match your contributions. What does that mean? It means you lose all of the above benefits, the most important of which is the fiduciary standard. In practice, this can be seen most frequently with teacher 403(b)s. No match. No fiduciaries. And many school district 403(b)s offer multiple vendors with different investments, fees, and disclosure practices. Teachers might be the most abused retirement investors out there due to this rule. A nonprofit website known as 403(b)wise.org has been working on this problem for more than two decades with only limited success. Interestingly, the site has compiled a list of vendors that are “green” (go ahead and use) and “yellow” (use caution but good investments are available if you look carefully). If you or someone you care about has a teacher 403(b), you should make sure they're using one of these vendors—preferably a green one—and help them switch if they are not.

The lists at the time I wrote this article included:

Green

• Aspire Financial Services
• CalSTRS Pension 2 (California only)
• Fidelity Investments (not American Fidelity)
• MissionSquare (formely ICMA-RC)
• T. Rowe Price
• Vanguard
• WEA Member Benefits (Wisconsin only)

Yellow

• Lincoln Investment (RetirementSolutions Participant Directed Program)
• PlanMember (Participant Choice)
• Security Benefit (DirectInvest)

Since vendors have no fiduciary duty to the participants, bad plans from bad vendors are often full of high-expense ratio mutual funds and high-fee annuities where the fees may exceed 3% per year. That will take a terrible toll over time. It also makes matching contributions less common in a 403(b) (since that would make ERISA apply). While a 403(b) plan theoretically could be cheaper to administer because they don't have to comply with all those pesky ERISA regulations, the terrible fees more than wipe out any potential advantage there.

Having set up a 401(k) plan for employees, I know the nice thing to do is for the plan/company to pay as many of the expenses as possible rather than having those come out of the employee's accounts with high fees. This allows participants (including the company owners) to get as much as possible into retirement plans and for those investments to grow as quickly as possible while paying expenses with the employer's pre-tax money. Many 403(b) vendors, plan administrators, and leadership in nonprofit institutions do not feel the same way and just pass all of the expenses (and more) on to the plan participants.

Often the secret to lowering your 403(b) fees is to NOT list an advisor for your plan. It may not be clear when you sign up that leaving that line blank is an option.

403(b)s, while similar, are not the same as 401(k)s. Sometimes it is important to understand the differences and where they came from historically.

What do you think? Did I miss any other differences between 401(k)s and 403(b)s? Would you rather have a 403(b) or a 401(k)?