All four are retirement plans classified as “defined contribution” plans. All four are offered by employers through a third party financial institution called an “administrator” as a tax-deferred investment vehicle to encourage you to save for retirement. So what’re the differences?
The main difference is who can contribute to each plan1:
- 401(k) – Offered to employees of for-profit corporations.
- 403(b) – Offered to employees of nonprofit organizations.
- 457 – Offered for state and municipals employees.
- TSP or “Thrift Savings Plan” – Offered to federal employees.
But there are a few other differences…
401(k)s have a base annual contribution limit of $18,500 for 2018 with an additional catch-up contribution of $6,000 for those age 50 or older.
To protect from employees abusing these vehicles for purposes other than retirement, the government charges a penalty of 10% (in addition to taxing your withdrawal as income) on any amounts you withdraw from these accounts prior to age 59 ½.
An exception to the 10% penalty is made for a few rare scenarios including:
- If you become permanently disabled and need to stop working.
- To pay for excess medical bills costing more than 7.5% of your income.
- Being called to active duty for at least 180 days.
- Separating from an employer at age 55 or later (50 or later for public safety employees).
Furthermore, you cannot take in-service (while employed) withdrawals at all (not even with a 10% penalty) unless you experience a hardship including2:
- Unreimbursed medical expenses for you, your spouse, or dependents.
- Purchase of an employee’s principal residence.
- Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
- Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
- For funeral expenses.
- Certain expenses for the repair of damage to the employee’s principal residence.
Or if your employer offers one of the legal non-hardship in-service withdrawals3:
- Employer contributions: match, profit sharing
- Employee after-tax (not Roth) contributions
- Employee pre-tax and Roth contributions only if the employee reaches age 59-1/2
All the above also applies to rollovers except after you leave your employer, afterwhich you can do a rollover to another plan or IRA.
Some administrators allow you to borrow up to 50% or $50,000 (whichever is less) from your 401(k) without paying taxes or penalties, but you would need to pay the amount back with interest, usually within five years. Furthermore, some administrators will not allow you to make contributions until the loan is repaid which would cause you to miss out on any employer matches and tax deferrals from those missed contributions. If you quit or are terminated from your employer, you must repay your loan within 60 days or your loan will be considered a withdrawal subject to taxes and penalties. Because of these negatives, loans from these plans are rarely a good idea.
403(b)s, 457s and TSPs
The rules of a 401(k) apply to 403(b)s, 457s, and TSPs, with the following exceptions….
- Allow an additional catch up contribution of $3,000 per year for up to five years after working in the same nonprofit for at least fifteen years and if the employee contributed less than $5,000 on average per year previously (excluding any age 50 catch-up contributions). The cap on these additional contributions is $15,000 for a lifetime across all employers.4
- Some state and municipal workers have access to a 457 and a 401(k) or 403(b) and can contribute up to $18,500 each into both plans!
- 457s have no early withdrawal penalty, but withdrawals will still be subject to taxes.
- Don’t allow in-service (during employment) withdrawals
- An exception is allowed if the amount is less than $5,000, no tax-deferred contributions have been made in the last 2 years, and no prior withdrawal has been made in the plan.
- Another exception is allowed if the employee experiences an “unforeseeable emergency”, which is a severe financial hardship resulting from an illness or accident, loss of property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant or beneficiary.
- Deployed military members can contribute up to $55,000 total in 2018 with their employer.5,6
- Thrift Savings Plans (TSPs) are just like 401(k)s and the funds offered in TSPs have very low fees.