What is a 401(k) and 403(b)? : Easy Guide To Understanding

Understanding what a 401(k) and 403(b) are is very important. We never learn about either in school (at least I never did) and the first time I ever did was when I started my first job after college.

Even then, I didn’t know what it was all I knew was that I had one.

You can become an expert in your 401(k) or 403(b) but you really don’t have too. You do however, have to understand the basics to matter what.

what it is:

  • A 401(k) and 403(b) are both a type of retirement investment account offered by an employer.
  • The main difference between the two is that a 403(b) is offered by nonprofit organizations and government employers.
  • If your employer does not offer a 401(k) or 403(b), you can still have a retirement savings account. There are other types of accounts that you can get elsewhere. For example, through Fidelity or Vanguard.

how it works:

  • You will decide how much money you want to contribute to your account.
    • Some companies default to a specific percentage but you can change that. 
  • Your contribution is automatically deducted from your paycheck and transferred to your retirement account. 
  • There are tax benefits to contributing to your retirement account. Your contribution will reduce your taxable income which means you will pay less taxes, for example:
401(k) or 403(b) Contribution = 5%$125401(k) or 403(b) Contribution = 0%$0
Taxable Income$2,375Taxable Income$2,500
Tax Rate (10%)$238Tax Rate (10%)$250
You can see from this example that if you contribute to your account, you pay less taxes.

  • The money in your account is used to invest in a mix of investments. The investments can be; stocks, bonds, mutual funds, ETFs. I wouldn’t worry about the specifics just yet! The investment mix is usually selected for you based on the year that you will retire.

important to understand:

  • Employer match. Some employers will also make contributions to your account. Some will match 100% of your contributions, others will contribute 50% of what you contribute. Every company is different, just know that it exists and it’s a great perk if your company offers it.
  • You will receive the benefits of compound interest. Your money will continue to grow over time without having to pay taxes upfront.
  • You will eventually pay taxes. You eventually pay taxes when you take money out of your account.
  • Early withdrawal penalty. If you take money out of your account before the age of 59 ½ you will have to pay a penalty. There are some exceptions, for example, if you have high medical bills or go on disability.
  • Contribution Limit. The IRS limits how much money you can contribute to your account each year. In 2020, the max contribution is $19,500. I think this won’t be a problem for most of us 🙂 
  • Vesting period. Some companies have a vesting period which means the money that your employer contributes to your account will not be yours until after having worked for the company for a certain number of years.
  • Fees. You will most likely be charged a maintenance fee. This is usually very low!

key takeaways:

  • If there is one thing to remember, it’s to start contributing to your retirement account as soon as possible. 
  • Talk to HR to better understand your company’s plan. You get a lot of paperwork that’s really confusing so setting up a call with HR can be helpful!
  • Unless you absolutely have too, don’t take money out of your account before you turn 59 ½.

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