403(b) and 401(k) are retirement plans that offer tax-efficient ways for employees in the workforce to save for retirement. The main difference between the two plans falls on the requirements each plan places on the employer when it comes to plan participation. 401(k) plans are offered by businesses, while 403(b) plans are limited to those working for organizations such as hospitals, churches, and public schools.
403(b) plans are retirement offerings are made available to qualifying employees of tax-exempt and nonprofit organizations. 403(b) plans are tax-deferred, meaning that contributions and accumulated earnings within the plan are taxed only once the participant withdraws money upon retirement. In an effort to encourage retirement savings among participants, 403(b) plans are subject to certain tax penalties if money is withdrawn before retirement.
A 401(k) is a retirement plan where an employer diverts a portion of an employee's salary to a retirement account designated specifically for that worker. 401(k) plans are defined contribution plans, meaning that they allows employers to match contributions up to a certain percentage of of employee-directed contributions. All 401(k) contributions are made with pretax dollars, and the maximum percentage of employer contribution is 15 percent of the employee's paycheck.
Income taxes for employees participating in either a 403(b) or 401(k) plan exclude the salary deductions directed into these plans. However, withdrawals from both are taxed as ordinary income. If one were to withdraw money from his retirement plan, whether it's a 403(b) or a 401(k), he would be subject to a 10 percent early distribution penalty. However, this penalty may be waived in certain circumstances, such as if the plan owner becomes disabled, separates from service after the age of 55, needs to pay for special medical expenses, has a desire to reduce excess deferrals or contributions in the future, or dies.
To establish a 403(b) plan an employer must be a public educational 403(b) institution, a church organization, or a tax-exempt 501(c)(3) organization. There are no such eligibility requirements for employers of 401(k) plans; unlike the 403(b), 401(k) plans are generally offered by for-profit companies. Businesses and organizations establishing 401(k) retirement plans must cover all employees who are 21 years old or older, work 1,000 hours per year, and have one year of service. Institutions administering 403(b) plans must make such plans available to full time employees who are at least 21 years of age and have completed one year of service.