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What’s the Difference Between 401(a) and 403 (b) Plans?

Javier Simon, CEPF®
401(a) vs. 403(b)

If you work for a public school or some kind of non-profit organization, you may have access to a 401(a) or a 403(b) plan. Both are retirement savings vehicles that offer major tax breaks. However, they are structured a bit differently. We’ll define both plans, as well as explain the pros and cons of each. We can also help you find a financial advisor to help you create a personalized retirement-planning roadmap.

What is a 401(a) Plan?

A 401(a) plan is a type of employer-sponsored retirement plan that functions similarly to a 401(k) plan. The main difference is that private companies typically sponsor 401(k)s. Meanwhile, government agencies, educational institutions and non-profits typically sponsor 401(a)s.

In addition, 401(a) plan sponsors typically enjoy a greater degree of control in plan structure. For instance, an employer decides on eligibility requirements. In most cases, employers make it mandatory for eligible employees to enroll. This may sound harsh. But they are helping employees save for their retirement and offering tax incentives.

Plus, the IRS makes it mandatory for employers to contribute to their own employees’ 401(a) plans. This is perhaps one of the only real instances of “free money” you can encounter. This rule applies even if the sponsor decides to make employee contributions optional.

Employers also decide on the vesting schedule and contribution structure. An employer can decide to defer a set percentage of each employee’s salary or paycheck into his or her corresponding plan. The rate can be set for the life of the plan, or the employer can allow employees to change it at a specific point during the year.

But beyond the mechanics of a 401(a) plan, the savings vehicle also enjoys a similar tax treatment to the 401(k) plan.

Tax Benefits of 401(a) Plans

When you invest in a 401(a) plan, you contribute pre-tax dollars. This means your employer deducts your contribution from your paycheck before Uncle Sam takes a big cut. As a result, it effectively reduces your taxable income. In addition, you may qualify for tax credits based on your contributions for the year.

Depending on your employer, you can choose from a range of investment options to contribute to. These typically include stocks, bonds and mutual funds that established investment firms manage. While your money stays in the plan, it grows tax free. So unlike your standard brokerage account, Uncle Sam won’t tax the interest, dividends or capital gains each year.

However, you will owe regular income tax when you make qualified withdrawals. You generally can make these once you reach age 59.5. Otherwise, you’d owe a 10% early-withdrawal penalty in addition to income tax on the amount. The IRS may spare you from the early-withdrawal penalty if you used the money for certain unexpected medical emergencies.

Some employers may also offer an after-tax 403(b) plan.

401(a) Contribution Limits

For 2018, the contribution limit for a 401(a) plan stands at $55,000. It climbs to $56,000 in 2019. This limit applies to total contributions you and your employer make. But if you make less than the contribution limit, the IRS will only permit you to contribute your total salary.

So if you make $45,000 a year, that’s how much you and your employer can contribute toward your 401(a) for the year. Of course, you’d need most of your pay to cover living expenses. Nonetheless, the contribution limit for any 401(a) participant is generally high compared to other types of plans.

What is a 403(b) Plan?

401(a) vs. 403(b)

A 403(b) plan is a tax-advantaged retirement plan typically reserved for employees of public schools and 501(c)(3) organizations. Below are examples of the types of organizations that may offer 403 (b)s:

  • Public schools
  • Cooperative hospital organizations
  • 501(c)(3) tax-exempt organizations
  • Religious institutions

403(b) plan sponsors decide on eligibility requirements for the plan. The IRS generally restricts them to establish accounts as one of the following, however:

  • Annuity contract with an insurance company
  • Custodial account that invests in mutual funds
  • Retirement income account investing in annuities or mutual funds for religious organization employees

Still, most 403(b) plan investment menus tend to offer annuity options from insurance companies. On the other hand, 401(a) plan options typically include mostly mutual fund investments.

Depending on your risk tolerance and financial goals, you may prefer one over the other. But no two plans are created the same. So the choice depends partially on which one offers the investments you feel are right for you (granted that your employer offers both a 401(a) and 403(b) plan.)

Tax Benefits of 403(b) Plans

In terms of tax treatment, a 403(b) functions similarly to a 401(a). You make pre-tax contributions, and your money grows tax-free. However, you will owe regular income tax on eligible withdrawals. You can also make these at age 59.5. The 10% early-withdrawal penalty rule applies.

403(b) Plan Contribution Limits

The 403(b) plan contribution rules can get pretty complex. But we’ll break it down for you. Under IRS rules, employees can contribute up to $18,500 in “elective deferrals” toward their 403(b) accounts in 2018.

Elective deferrals refer to the money taken out of your salary or paycheck and put into the plan. If your employer contributes to your plan, it can contribute up to an extra $36,500 in “annual additions.” This raises the limit to $55,000. But if you’ve capped out your elective deferrals and you’re at least 50-years-old, you can make additional “catch-up” contributions worth $6,000.

However, if you make less than the annual additions limit ($55,000), your maximum equals your total annual compensation. So if you make $45,000 in 2018, that’s the maximum that you and your employer can contribute toward your plan for the year.

Simple answer: your maximum contribution limits equal your total annual earnings.

Your plan may also allow the “15-year” catch-up rule. So if you’ve worked for your employer for at least 15 years, and your average annual contributions were less than $5,000 during those years, you could contribute an additional $3,000 per year capped at $15,000 for a lifetime. And if you’re at least 50-years-old, you can take advantage of both types of “catch-up” contributions.

But make sure you check your plan to see if they allow this additional catch-up contribution. If so, also make sure you’re aware of the rules behind it.

401(a) vs. 403(b)

The Takeaway

401(a) and 403(b) plans ultimately function very similarly. The main difference lies with who is eligible to enroll in each and the plan design of the one that employer happens to offer. 401(a) plan sponsors generally make it mandatory for eligible workers to enroll in the plan but contribute to their employees’ plans as well. They also set contribution models in most cases. 403(b) plans typically make this voluntary. However, specifics like investment options depend solely on the discretion of your employer. In any case, you should examine which seems more beneficial to you based on your financial goals and risk tolerance.

Tips

  • Your retirement strategy involves more than just an employer-sponsored retirement plan. You can also factor in Social Security benefits. To help you crunch the real numbers, we developed the best retirement calculator around.
  • One of the best moves you can make when mapping out your retirement is to work with a financial advisor. Our SmartAsset financial advisor matching tool connects you with up to three advisors in your area. From there, you can examine their credentials and even set up interviews before working with one.

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