Money & Finance

Best Retirement Plans: 401k vs 403b vs IRA vs Roth IRA

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Three piggie banks on books with retirement on chalkboard
Which piggy bank: 401k, 403b, IRA, or Roth IRA will give you the biggest return on your investment? Find out in our comparison.

It’s never too early (or late) to start investing in your future. Retirement plans are a smart way to help ensure you’re financially secure when you need it. Saving a little can go a long way in the long term for your financial goals.

Jeff Butler is our financial guru, holding an undergraduate degree in Finance from Malone University. He has a diverse background in small business ownership, accounting and property management. With his expertise in personal finance, Jeff consults on and reviews our investing and financial content, including this article.

What Are The Different Types Of Retirement Plans?

There are many different types of employer-sponsored and self-directed retirement plans. In this article, we’ll discuss the most common types and give information to help you compare retirement plans.

1) Employer-Sponsored Retirement Plans

  1. 401(k) plans and Roth 401(k) plans are for employees of public or private companies.
  2. 403(b) plans are for employees of non-profit or tax-exempt organizations, such as public schools, colleges, philanthropic organizations, hospitals, libraries and churches.
  3. 457 plans are for employees of state and local municipal governments.
  4. Thrift Savings Plans are for federal civilian and uniformed services employees, like U.S. postal workers.

2) Self-Directed Retirement Plans

  1. Traditional IRA
  2. Roth IRA

What Is A 401(k) Retirement Plan?

A 401(k) is the most popular type of retirement savings plan that’s sponsored by an employer. The benefit of a 401(k) plan is that it allows employees to save and invest part of their paycheck before the government takes out taxes. Employees don’t pay taxes on their contributions until they withdraw money from the account.

Another huge benefit for employees? Many 401(k) plans include a matching employer contribution — your employer kicks in $0.50 for every dollar you contribute up to a certain percentage of your salary (3% is the most common, but some will go as high as 6%).

What Is A 403(b) Plan?

The 403(b) is nearly identical to a 401(k) plan except it’s available to employees of educational institutions and certain non-profit organizations as determined by section 501(c)(3) of the Internal Revenue Code. A 403(b) plan works the same way as a 401(k) regarding the withholding process, contribution limits, withdrawal policies and other details.

401(k) vs 403(b)

A 401(k) is a retirement savings plan offered by for-profit employers, while a 403(b) is a retirement savings plan offered by nonprofit organizations. Both types of plans allow employees to contribute a portion of their salary on a tax-deferred basis, meaning that they don’t pay taxes on the money they contribute or on the investment earnings until they withdraw the funds during retirement. Employers may also offer matching contributions as a way to encourage employees to save for retirement.

Contribution Limits

Both 401(k) and 403(b) plans have annual contribution limits that are set by the Internal Revenue Service (IRS). In 2021, the contribution limit for 401(k) plans is $19,500 for employees under the age of 50, and $26,000 for those 50 and over. The contribution limit for 403(b) plans is the same as for 401(k) plans.

If you work for a company that offers matching contributions, the total annual contributions may not exceed the lesser of a) 100% of your total annual compensation or b) $54,000.

Investment Options

There are some differences between 401(k) and 403(b) plans, however. For example, 401(k) plans may offer a wider range of investment options, such as stocks, bonds, and mutual funds, while 403(b) plans may be more limited in the types of investments they offer. Additionally, 401(k) plans are subject to certain rules and regulations that do not apply to 403(b) plans, such as the requirement to perform annual nondiscrimination testing to ensure that the plan benefits highly compensated employees (HCEs) no more than it benefits non-highly compensated employees (NHCEs).

Overall, 401(k) and 403(b) plans are both good options for saving for retirement and can help employees build a solid foundation for their financial future. It’s important to carefully review the terms and conditions of any retirement savings plan before making a decision to participate.

How Do 401(k) And 403(b) Plans Work?

  • Participation in a 401(k) or 403(b) plan is optional for employees.
  • You decide the percentage of your salary that you’d like to contribute, and that amount comes out of your paycheck and goes into your account every pay period.
  • You decide how you invest your money. Your employer’s plan has a selection of investments for you to choose from. Most plans offer a diversified spread of mutual funds, including stocks, bonds and money market investments.
  • When you leave your job, you still own your account; your employer can’t touch your funds.

When Can You Withdraw Funds From Your 401(k) Or 403(b)?

While you can withdraw funds before the age of 59 ½, you’ll incur a hefty 10% penalty (on top of the taxes owed on your contributions). Depending on when you withdraw funds, you may not be eligible for employer matching contributions.

Many plans require a set number of years in service to be vested in matching contributions. For example, a plan may require that you work for two years for a 25% vested interest in matching contributions. The longer you remain employed, the higher the vested percentage.

Traditional 401(k) vs Roth 401(k)

Some employers offer the less common Roth 401(k) plan, which combines features of both a traditional 401(k) and a Roth IRA (see below for more information on Roth IRAs). You contribute after-tax dollars to a Roth 401(k).

While you don’t get the upfront tax break with a Roth 401(k), your account grows tax-free, and you won’t incur taxes when you make your withdrawals at age 59 ½.

 Traditional 401(k)Roth 401(k)
ContributionsContributions made with after-tax dollarsContributions made with before-tax dollars
Income LimitsNoneNone
Maximum Individual Contribution$18,000 (plus an additional $6,000 for employees 50 and older)$18,000 (plus an additional $6,000 for employees 50 and older)
Withdrawal TaxationNo withdrawal taxes if you hold the account for 5 years and you’re withdrawing on account of disability, after death or age 59 1/2Subject to Federal and most State income taxes
Required DistributionsMust begin at age 70 1/2, unless still working and not a 5% ownerMust begin at age 70 1/2, unless still working and not a 5% owner

What Are Your Options If You Leave Your Employer?

If you leave your job, you typically have these four options for what to do with your 401(k) or 403(b) account:

  1. Roll over your account into your new employer’s plan.
  2. Roll over your account into an Individual Retirement Account (IRA).
  3. Some companies will allow you to leave your balance in its plan (check with your former employer’s plan administrator).
  4. Withdraw your account balance in a lump sum cash payout. This option, however, isn’t advisable because you’ll incur steep income taxes on top of a 10% early withdrawal penalty.

What Is An IRA?

An IRA is a savings account with attractive tax breaks that allows you to put more money away for your retirement. Most IRAs are accounts that you open on your own, unlike employer-sponsored 401(k) or 403(b) plans.

There are several types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. The latter two types are for self-employed individuals and small businesses.

How Do You Benefit From An IRA?

One of the biggest advantages of an IRA: Your plan grows free from Uncle Sam’s grips. The income from interest, capital gains, and dividends compound each year without being taxed.

Depending on whether you choose a traditional IRA or a Roth IRA, you either put your money into the plan initially tax-free or withdraw your money upon retirement tax-free. More about Roth IRAs in a bit.

Sounds like a no-brainer, right? Are there caveats? Unfortunately, yes. Not everyone can take advantage of an IRA plan. There are eligibility restrictions with each type of IRA, largely based on your income or employment status.

The annual contribution caps for IRAs are pretty limited. Like a 401(k), you also incur a penalty for withdrawing funds before a designated retirement age.

What Is A Roth IRA?

The two most common types of IRAs are a Traditional IRA and a Roth IRA. With a Roth IRA, you pay taxes before you put your money into the account. But earnings and withdrawals are generally tax-free.

Roth vs. Traditional IRA: How Do They Compare?

As you’ll see from the table below, there are advantages to each type of IRA.

 Traditional IRARoth IRA
Who’s Eligible?Anyone who has taxable compensation, unless you’re age 70 1/2 or olderVarying income limits
Are Your Contributions Deductible?Yes, in full if you don’t have a work retirement plan. Limited if you do.No
Annual Maximum Contribution Limits$5,500 (or $6,500 if you’re age 50 or older)$5,500 (or $6,500 if you’re age 50 or older)
Are Withdrawals Taxed?YesNo (if you’ve met the 5-year account requirement and you’re age 59 1/2 or older). Yes, otherwise.
Required DistributionsYes, once you turn 70 1/2.Not if you’re the original owner.

Where Should I Begin Investing?

The video from comedian John Oliver below gives you some great tips on how to get started investing in a retirement plan (along with a few punch lines). It’s a little lengthy but worth a watch.

Still Confused? Here Are 4 Steps To Get Started

It’s not easy deciding which type of retirement plan to invest in, especially if you’re many years away from retirement. Every person’s situation is different, depending on income, the age you begin, your future plans, etc. But here are some general tips to help you choose the best retirement plans.

  1. Begin with a 401(k) if your employer offers matching contributions. If you can, contribute enough to get the maximum matching dollars. Free money for your future? Score!
  2. If you’ve contributed enough to meet the maximum matching dollars, then open an IRA if you wish to put more money aside.
  3. If your employer doesn’t offer a matching 401(k) plan, invest first in an IRA. Why? You’ll have a wider variety of investment options, and you won’t incur an administrative fee that employer-sponsored 401(k)s usually charge.
  4. Once you max out your IRA’s annual contribution limit of $5,500 ($6,500 for age 50 and older), turn to your 401(k) plan to invest more for your future.

Saving For College?

If you’ve got kids and haven’t heard of 529 plans, now is the time to! These plans are specifically designed to make saving for future education costs as easy as possible. They also carry some enticing benefits compared to other types of investment savings plans. See what 529 plans have to offer and if they’re the best fit for your financial planning needs.

Sally Jones

While attending the University of North Carolina at Chapel Hill’s graduate school for journalism and public relations, Sally began a long career researching and writing about hard-to-understand topics, such as insurance and finance. Her additional experience in marketing, fundraising, public relations and financial planning at various foundations and nonprofit organizations over the years has given her the practical tools to inform consumers about making the smartest business and personal financial decisions. Her work has appeared in many notable media outlets, including The Washington Post, Entrepreneur, People, Forbes, Huffington Post, and more. Speaking of smart living — growing up in the (at-the-time) per-capita murder capital of the U.S. (Richmond, VA) taught her a thing or two about the need for personal and home safety. Sally stays on top of all the latest gadgets and services to protect her and her teenage daughters from potential predators and thieves. And she brings this knowledge to every article she writes.

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