Explaining the Retirement Soup of 403(b), 457 & 401(k)
I have heard a 403(b) be referred to as a 504(b), a 4(b)3(K), or some alphabet-number soup more times than I can count. I understand how the numbers and letters may be confusing. However, they are probably more familiar that you may think. Let me break this down to be as simple as possible.
403(b), 401(k) and 457 are retirement plans offered by employers, allowing their employees to save for retirement directly from their paycheck. What is available to you, the employee, is determined by how your employer files their taxes.
- 401(k)’s may be the most well-known. This is the retirement plan offered to employees of “for-profit” companies. Think 3M, Best Buy, Target.
- 403(b)’ are retirement plans available to employees of non-profit companies. Think school districts, some hospitals, work-force centers, possibly a day-care center.
- 457’s are retirement plans offered to city/state/government employees. City of Minneapolis, Douglas County, MN DOT, etc.
What do the different numbers and letters mean? The numbers and letters correlate to the subsection of the IRS Code in which they are defined.
While there are slight differences between each plan, they are very similar. Think of them as first-cousins of each other. All plans allow the employee to determine:
- how much they want to defer (save) per paycheck,
- how their deferral is invested
- upon retirement, how they wish to take distributions.
While contributing, employees are allowed change their deferral amounts and change the investment within the eligible investment options.
In retirement, the investor chooses to take distributions as they need, or they can set up a systematic payment; meaning an amount monthly, quarterly, semi-annually or annually. The investor can change the distribution method and amount as needed. Being able to change the distribution amount and distribution method in retirement offers flexibility different from Social Security and pension (TRA or PERA).
The monthly benefit payments of social security and pension is a set amount based on a formula of how long you work, your salary during your working years and the age at which you take benefits. Once benefits start, you cannot change the amount you receive. As an example, if you need an additional $1,000 per month in retirement, pension and social security will not be able to increase to cover this need. With a 401(k), 403(b) or 457, it’s your money! If you have the money in your account, you can take more. Another way to think of this is to think of this account becoming “your employer” in retirement. The larger the account balance at retirement, the better paying and more flexible job you may have! To have the opportunity for that better paying and more flexible job in retirement, the trick to get started in the plan your employer offers as soon as possible and consciously fund it!
Content in this material is for general information for education purposes and is not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.