Current Thinking

What Is The Difference Between A 401(k) Plan And A 403(b) Plan?

Both 401(k) and 403(b) plans are retirement plans that are sponsored by an employer. Both must meet IRS requirements to allow tax-free contributions. However, 401(k) plans are offered by for-profit companies whereas 403(b) plans are offered by not-for-profit organizations that are tax exempt under IRS Code 501(c)3, such as educational institutions, school districts, governmental organizations, religious organizations and hospitals.

The rules for both types of plans are similar, but there are some significant differences, regarding contribution limits, investment choices and rollover options.

WHICH CONTRIBUTION RULES ARE DIFFERENT FOR A 403(b) PLAN VS. A 401(k) PLAN?

In a 403(b) plan there are special contribution limit rules. Both 401(k) and 403(b) plans are subject to the rules of IRS Code 415 but how they apply to each plan type does differ. A company with a 401(k) plans can combine 401(k) elective deferrals with contributions from other qualified retirement plans they sponsor and there is one 415 limit. If a not-for-profit organization has a 403(b) and a 401(a) plan, both with employer contributions, each plan would have its own 415 limit.

Annual limits are the same however, and 403(b) plans also have a Long Service Catch-up contribution provision, in addition to the Age 50 catch-up provision of $5,500 (for 2012). A 403(b) plan participant with 15 years of service can make an additional catch-up contribution of up to $3,000 (for 2012).

In addition, 403(b) plans also have a special rule that allows employer contributions up to five years after someone is terminated from employment. This is not allowed in 401(k) plans.

WHAT ABOUT COMPLIANCE TESTING?

403(b) plans are subject to compliance testing but not subject to the non-discrimination testing requirement for salary deferrals, whereas 401(k) plans are.

ARE THERE ANY DIFFERENCES REGARDING INVESTMENT OFFERINGS?

Yes, there are. 403(b) plans are limited to annuities contracts through insurance companies or custodial accounts that are invested in in mutual funds. The investments can be individual or group contracts or accounts. 401(k) plans have a wider range of investments. There is no trust requirement for ERISA 403(b) plans as there is for 401(k) plans. Annuities and custodial accounts qualify as an alternative to a trust under ERISA 403(b). In a
401(k) plan only annuities qualify as an alternative to a trust, custodial accounts do not.

WHAT IS THE DIFFERENCE BETWEEN AN ERISA 403(b) PLAN AND A NON-ERISA 403(b) PLAN?

The major difference between an ERISA 403(b) plan and a Non-ERISA 403(b) plan is the level of employer involvement. If a plan falls under ERISA there is a significant amount of employer involvement that is necessary. The employer chooses the types of investments option based on what is best for the plan and sends the payments to the plan, often matching employee contributions. Under ERISA, the employer must manage the plan and select investment types in the best interest of the employees participating in the plan. In a non-ERISA plan, the employee chooses the type of investment and usually will work directly with an investment advisor. The money from employees is collected by the employer and then sent to the plan administrator. There is no other involvement on the part of the employer.