Is a 403(b) or 401(k) Better for Retirement? Here’s How To Decide

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The two most popular employer-sponsored retirement plans are the 401(k) and 403(b), but which one is better depends largely on what your employer offers and your personal situation. 

Both accounts can be a big part of your financial well-being. They’re both efficient ways to save for retirement, but each has a couple of key differences. The 401(k) retirement plan is offered from a for-profit company and a 403(b) is offered from a not-for-profit company. 

Both account types “allow for a diverse group of investments,” says Kimberly R. Nelson, CFA®, advisor at Coastal Bridge Advisors. For the most part, “they function identically,” and it’s a smart idea to opt into whichever one is available to you. 

Let’s look at the differences between a 401(k) and a 403(b) plan, so you can decide which is better for your situation. 

What Is a 401(k)?

A 401(k) is a retirement account sponsored by a for-profit company that allows employees to contribute tax-deferred, or tax-free dollars. Many employers also offer a company match, or free money, to employers.

A 401(k) can be available in a traditional or Roth version. With a traditional 401(k), you opt to take a tax break on your annual tax return. In exchange, you pay taxes when you withdraw your funds. These distributions are taxed as ordinary income, and the tax you’ll pay depends on which bracket you’re in at the time of withdrawal. 

For the Roth version, you contribute after-tax dollars, meaning you’ve already paid tax on the funds. In exchange, your money grows tax-free and there’s no tax when you withdraw, assuming you’re over 59 ½ and have met any other rules of your plan. 

Whether traditional or Roth is better depends on your income, what tax bracket you might be in when you retire, and other personal factors. 

What Is a 403(b)? 

A 403(b) is a retirement account sponsored by a non-for-profit company or governmental agency. It’s also available to church members and public school employees. 

Like a 401(k), some employers also offer traditional and Roth versions of 403(b) plans. The tax benefits and implications work the same way as a 401(k), and the contribution limits are the same. You’ll also find a variety of good mutual funds as well. 

In 2022, you can contribute up to $20,500 through payroll deductions, with an additional $6,500 in catch-up contributions for people age 50 or older. Employers can choose to match your contributions, and the maximum yearly cap is $61,000 or 100% of your annual salary, whichever is less — the same as a 401(k).

Pros and Cons of 401(k)s

A pro and a con for any employer-sponsored retirement plan is “you can only choose the investments the plan administrator allows you to choose from,” Nelson explains. It’s usually a small pool of options, but you can get good diversification through low-cost index funds. Most plans have at least a few of these.

A big pro of a 401(k) is that “your company might be sharing some of their profits with you through [your] 401(k),” Nelson says. That’s something you won’t get access to with a 403(b) plan. 

Another benefit is 401(k) plans are regulated by the Employee Retirement Income Security Act, or ERISA, “a special set of laws that protects the interests of plan participants,” according to Nelson. “There’s compliance guidance for the plan sponsors regarding their fiduciary duties. It’s an extra layer of protection for whatever you’re investing in through these plans.” 

These protections make sure your employer’s retirement plan has minimum standards for participation and requires them to make information about the plan available to employees.  

Pros and Cons of 403(b)s 

The biggest con of 403(b) plans is that they’re only subject to ERISA protections if the employer offers a match. Because of this, the majority of employers that offer 403(b) plans don’t match employee contributions. Getting a match is like getting free money toward your retirement, and a big reason why 401(k) plans get higher enrollment rates. 

Another downside is that many employers that sponsor 401(k) accounts also elect to share profits through them. Because 403(b) accounts are for non-profit companies, you won’t be receiving any extra funds this way. 

“A lot of 403(b) plans still have an annuity component to it, like a pension-style program that you can also participate in,” explains Lauren O’Brien, CFP®, CPA, senior wealth advisor at XML Financial Group. Many people find annuities hard to navigate, and most experts don’t recommend them. Because there are many other options these days, you don’t have to think about getting an annuity unless you want to. 

On the plus side, because many 403(b) plans are cheaper to manage, your investment options usually have lower expense ratios, which means more money stays in your account as it grows. And to make up for any slack, many 403(b) accounts feature immediate vesting of all your funds, which is something most 401(k) accounts don’t have. That means that anything in your account, including your employer match (if there is one), is immediately available to you – but check the rules of your particular plan. 

Is a 401(k) or a 403(b) Better for My Situation?

A 401(k) and 403(b) plan function virtually identically with a couple of different settings under the hood. Both types of accounts have the same contribution limits and maximums, can offer traditional and Roth variations, and require participants to be 59 ½ or older before withdrawing without penalties. 

Both will have vastly similar investment options, with 403(b)s having added emphasis on annuities. 

If you’re in the rare position of being able to choose between either type of plan, it will come down to the actual details of the plan, says O’Brien. She recommends understanding exactly how much is being contributed on your behalf, and, if you can, what fund options are available. 

“It’s going to come down to what kind of work you’ve chosen to do,” Nelson says. If you’re a teacher, for example, you’re only going to have a 403(b). But it’s nothing to worry about. Because the two plans are so similar, “you’re not harmed in any way,” and one isn’t safer than the other. 

Ultimately, the best course of action is to opt into whichever retirement account is available to you and maximize the benefits early and often. If your plan offers a traditional and Roth version, decide if you’d rather have a tax break upfront or down the road in retirement. In general, high earners will want to reduce their taxable income and go with the traditional option, while those in a lower tax bracket with many years until retirement could consider the Roth version. As always, consult a tax professional about your specific situation.