401(k), 403(b), 457(b) – What are they and what’s the difference?
By: Jeremy Skoglund, VP Trust Officer
I tend to make the mistake of thinking that everyone knows what a 401(k) is. I was introduced to a 401(k) at my first job out of college and have participated in one ever since, but I forget that I had no idea what they were talking about when I first started working. As I think back, I remember wondering what was with calling something a random number with a letter after it. Why not just call it a Retirement Plan? Being in banking for many years, I’ve realized we use a lot of acronyms to describe things (IRA, CIF, ACH, APY, KYC, AML, NOW – I could go on and on). To be fair, we aren’t the only industry that uses acronyms. I’m sorry if we bankers try to sound really smart in front of you as we ask you for your CIF info to complete our KYC due diligence to follow our AML procedures before we open your NOW account that has a small APY and will allow you to send money via ACH. I’m sure you feel like I do when I’m at my kids’ school listening to teachers talk about IEPs, APs, and ESL students.
401(k) isn’t technically an acronym, and neither is a 403(b) or a 457(b), so what is with all these random numbers and letters? They are named after the sections in the IRS tax code that governs those specific plans. They are all retirement plans that offer a tax-advantaged option for you to save. You’re able to contribute the same amount ($18,500 in 2018) to each of these plans, and if you’re 50 or older, you can contribute an additional $6,000 as a catch-up contribution. So why are there different types of plans? Well, they have very slight differences.
If an employer offers a retirement plan, the most common is the 401(k) plan. The employee can contribute with funds coming out of their paycheck before taxes. The employer may or may not contribute to the employee’s plan. Once you retire, you will pay taxes on the funds you withdraw from the 401(k). If you withdraw funds before you turn 59 ½, there may be a 10% tax penalty.
The 403(b) plan is almost identical to the 401(k), but it is offered to employees of nonprofit organizations, religious groups, school districts, and governmental organizations. The IRS allows these organizations certain exemptions which ultimately lower the administrative costs for the plans.
A 457(b) plan is provided primarily to state and local government employees. Unlike the 401(k) and 403(b), there is no 10% tax penalty for withdrawing funds before you are 59 ½ if you are leaving a job or retiring. You don’t always get to choose which of these plans you participate in as it’s more dependent on what your employer offers, but we are always here to help explain the different types of retirement plans that could work for you. And I promise to try really hard to avoid using all those acronyms when we talk.
If you would like more information about 401(k), 403(b), 457(b) accounts , please give us a call: