401K

You’re Probably Going To Have One Of These Soon: 401(k) And 403(b) Plans Explained

You may have heard of 401(k)s, which are retirement saving plans where participants pay part of their income to an investment fund.

There is also a less well-known plan that could easily be confused with the 401(k): 403(b).

Fortunately, it’s essentially the same kind of plan as a 401(k), except that it’s available for public school, non-profit employees, and ministers, instead of private sector workers.

Eligibility for the plan is determined by the employer, based on factors such as hours worked, according to the 403(b) literacy site 403bwise.

How do the plans work?

With both plans, you give a certain amount of your income to an investment fund, which will invest that money for you and pay you back after retirement, as stated by the IRS.[contextly_auto_sidebar]

The money you give away is excluded from your income, so you don’t have to pay taxes on it (although they’re taxed as normal income when you withdraw, and there are penalties for early withdrawal).

Where does my money go?

With 401(k)s, you can choose what to invest in from a spread of bonds, stocks and money market investments. So-called target-date funds can help you make your investments gradually safer from risk as you near retirement, according to the Wall Street Journal.

The 403(b) plans are more limited, however. They are usually annuity contracts (yearly payments) with insurance companies, or investments in mutual funds (consumer investment companies that pool people’s money), 403bwise writes.

 

What are the benefits?

  • – High yields: aside from the tax relief, these plans can offer very high percentages of return, especially 401(k)s focused on stocks.
  • – Employers will give you money: With both types of plans, employers frequently offer matching contributions up to a certain point (most commonly 3% of your salary), meaning that if you contribute $1,500 of your $50,000 salary, they will contribute an additional $1,500 to your 401(k), the WSJ writes.

 

What are the downsides?

  • Risky: Especially with 401(k)s, investments can be volatile, and a desire for more returns can make it tempting to make high-risk choices
  • – Difficult to manage: Because you’re making your own investment decisions, these plans require a lot of time and effort to optimally select, as highlighted in an NPR documentary.
  • – Not necessarily adequate: The plans have only been around since the early ‘80s, when the obscure part of the tax code they are part of was discovered by the financial services industry.

It opened up a market for investment companies to attract more capital from workers, and it was advertised as a pension supplement.

However, over the last 30 years it has largely replaced traditional pension, which has led millions of Americans to save inadequately, according to Forbes Magazine.

Updated

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Ole Skaar