I field a lot of questions regarding the various rules that govern 401k and 403b plans. Not only is it a confusing topic for the average investor, but the issue has been gaining in importance recently as these plans become more popular. The reason why they have similar names which often confuse people is that both reference the section of tax code which defines how they are organized. It may be easier to refer to them as “for-profit” and “not-for-profit” plans because therein lies the primary distinction.
If you work at a for-profit corporation, you probably have a 401k plan available to you at work. If you don’t, well, that’s an issue you may wish to raise with human resources. Most financial advisors would agree that funds accumulated through company retirement plans will be essential in light of future uncertainty regarding government benefits. A 403b is only available to tax-exempt organizations, the most common of which are schools, hospitals, and religious groups. Section 501(c)(3) of the tax code goes into considerable detail about the rules regarding organizing your business as tax-exempt. As for what the benefits are to contributing to either a 401k or 403b plan, here is the short list:
• Participants set aside money on a pre-tax basis through payroll. Let me explain what that means: If $100,000 is your taxable income in 2006, and you defer $10,000 through payroll into either plan, your taxable income is now $90,000. This is the primary benefit to contributing on a “pre-tax” basis.
• The deferral amount, $10,000 in our example, is directed to the authorized vendors working with your organization. I will discuss the vendor issue in the next paragraph as there are things to know about where you are sending your money. If you get paid monthly and you have twelve pay cycles per year, $833 would be taken out of each cycle and sent to the vendor managing your plan.
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The differences between 401k and 403b plans
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