401(a) vs. 403(b): Ultimate Guide

Planning for retirement is an essential part of long-term financial security. Choosing the right retirement plan can significantly impact your ability to maintain a comfortable lifestyle after you stop working. Considering the rising cost of living, increased life expectancy, and the uncertain future of Social Security benefits, making informed decisions about your retirement savings is as crucial as it’s ever been.

In this guide, we’ll explore two employer-sponsored, tax-advantaged retirement plans: the 401(a) and the 403(b). Both plans are sponsored by nonprofit organizations, with different types used depending on the organization’s sector. The IRS sets the contribution limits for these tax-advantaged retirement plans, so understanding all relevant rules and policies is crucial.

We’ll delve into their features, compare their benefits, and discuss how to choose between them. Whether you’re a seasoned investor or a retirement plan newbie, this guide hopes to provide valuable insights.

What is a 401(a) Plan?

A 401(a) plan is a retirement plan primarily offered by state and local government employers, as well as specific nonprofit organizations. Like many retirement plans, 401(a)s are often used as an incentive to attract and retain employees. A 401(a) is set up by the employer, who makes contributions based on rules set by the IRS.

Unlike many other retirement plans, employer contributions to a 401(a) plan are mandatory. and they’re subject to a vesting schedule, which means you must remain with the employer for a certain period to receive the full benefit. This tax-advantaged retirement plan can help reduce your income tax burden, as contributions are often made with pre-tax dollars.

401(a) investment options tend to be fairly conservative — as well as fairly limited — relative to other retirement accounts.

As of 2023, the total contribution limit for 2023 is $66,000. The majority of voluntary contributions to a 401(a) plan is capped at 25% of an employee’s compensation for the year.

What is a 403(b) Plan?

A 403(b) plan is similar to a 401(a) plan, but it’s specifically designed for employees of public schools, nonprofit organizations, and specific tax-exempt organizations. Similar to most retirement plans, employees can make contributions up to IRS-defined employee contribution limits. These are often called elective deferrals, and are made on a pre-tax basis directly from your paycheck.

Unlike 401(a) plans, 403(b) plans also allow for catch-up contributions for those 50 and older, which can be beneficial for late-starters in saving for retirement. An additional unique feature of a 403(b) plan is the ability to invest in annuities alongside other, more comprehensive investment options.

As of 2023, the total contribution limit for a 401(a) plan is $66,000, with a $7,500 catch-up contribution available for those aged 50 and over. Employee contributions are capped at $22,500 ($30,000 for employees 50 and over).

401(a) vs. 403(b): Eligibility and Participation

While both the 401(a) and 403(b) plans are types of retirement savings plans offered by specific types of employers, their eligibility criteria differ.

• A 401(a) plan is typically offered to state and local government employees, as well as certain nonprofit organizations. 401(a) plan design, including eligibility and matching contributions, is typically established by the employer. Matching contributions are mandatory based on the employee’s salary, according to IRS rules.
• On the other hand, 403(b) plans are exclusively designed for employees of public schools, nonprofit organizations, and other tax-exempt organizations. In some cases, eligibility may depend on the length of service, meaning that an employee might have to work for a certain period (commonly at least a year) before being eligible to participate in these types of plans. Matching contributions are possible, but are not necessarily required.

401(a) vs. 403(b): Contribution Limits and Rules

Contributions to 401(a) and 403(b) plans can be made pre-tax, meaning they are deducted from your income before income tax is applied. However, the specifics of contribution limits vary between the two.

• For 401(a) plans, contribution limits include both mandatory employee contributions and employer contributions. The total amount of these contributions can’t exceed the IRS-defined limit for a given year. For 2023, that limit is $66,000 (total contributions from employee and employer)
• Conversely, 403(b) plans have specific limits set for elective deferrals, which are the contributions made directly from your paycheck. In 2023, the contribution limit is $22,500. These plans also allow catch-up contributions and additional contributions over the standard limit for those 50 and above ($7,500 for 2023).

As always, consulting with a financial advisor or the IRS guidelines is essential in learning about current limits and regulations.

401(a) vs. 403(b): Investment Options

Your retirement plan’s range of investment options can significantly impact its growth potential. In a 401(a) plan, investment options typically include lower-risk options like government bonds and well-diversified mutual funds. Your 401(a) plan sponsor will work with the plan administrator to select and monitor these options.

In contrast, 403(b) plans were initially designed to hold annuities. However, these plans now offer a wide range of mutual funds as investment choices, and generally offer a more comprehensive investment menu than do 401(a) plans. It’s worth noting that some 403(b) plans might still be limited to annuity investments, especially those provided by insurance companies.

As always, it’s crucial to understand the investment options in your plan to align them with your financial goals and risk tolerance.

401(a) vs. 403(b): Withdrawals and Distributions

The rules for withdrawals and distributions from both 401(a) and 403(b) plans are similar.

Generally, you can start taking penalty-free distributions after reaching retirement age (59 1/2), and the amount you withdraw becomes part of your taxable income.

However, if you take an early distribution before retirement age, that money will count as taxable income. In addition, you may have to pay an early withdrawal penalty (10%) unless you qualify for specific exemptions defined outlined under IRS rules.

Both plans allow rollovers to other retirement accounts like an IRA or another employer-sponsored plan. However, it’s essential to consider the potential tax implications of rollovers and ensure the rollover is processed correctly to avoid unexpected taxes or penalties.

401(a) vs 403(b): Tax Considerations

Because both accounts use pre-tax dollars, 401(a) and 403(b), plans offer tax advantages, such as pre-tax contributions and tax-deferred growth. At the same time, distributions from both 401(a)s and 403(b)s are generally subject to income tax.

Remember that only after-tax investments (like those from Roth accounts) can be withdrawn tax-free, so you’ll need to be especially mindful of income tax when you withdraw from your 401(a) or 403(b) in retirement (or before!)

Understanding each plan’s tax benefits and implications is essential when choosing the right retirement savings strategy. Consult with a financial advisor at a reputable Registered Investment Adviser to help navigate the world of tax planning.

Which Plan is Right For You?

The organization you work for will make this decision for you, so as an employee, you won’t need to worry about making a choice between the two types of plans. What you can do is learn about the plan your employer provides so as to take advantage of both the contribution limits as well as the underlying investment options in the plan.

Bottom Line: 401(a) vs. 403(b)

401(a) and 403(b) accounts differ in terms of their contribution limits and eligibility guidelines, but they also have numerous similarities.

At the same time, working with a professional can help you formulate the best retirement savings strategy while maximizing tax advantages and reducing your taxable income along the way.

If you want to take control of your financial future, consider partnering with Capitalize. We help you consolidate your retirement savings and manage your rollover which can be especially helpful when you change jobs.

Explore how we can help you build your financial future today.