How a 401k salary deferral plan
works
How a 403b salary deferral plan
works

401(k) Plan
  • Employer contributions are not currently taxable to employee and earnings accumulate tax deferred.
  • Most plans are self-directed (employee controls investments).
  • Investment risk remains on employee.

403(b) Plan
  • Employer contributions, if any, are not currently taxable to employee and earnings accumulate tax deferred.
  • Plan is self-directed (employee controls investments).
  • Investment risk remains on employee.

Employer
  • May provide a voluntary matching fund
  • Contributions are tax deductible to the business.1
  • May make discretionary contributions any year, so long as allocation is nondiscrimination.
  • Special rules apply for nondiscrimination.

Employer6
  • Contributions are tax deductible to the employer.
  • May make dicretionary contributions1 from year to year so long as allocation in nondicriminatory.

Employee
  • Employee elects to defer a portion of salary or bonus.
  • Amounts deferred are subject to FICA and FUTA taxes but not current income tax.
  • Employee's elective contributions are limited to $12,0002 per year (2003).3

Employee
  • Employee elects to defer a portion of salary.
  • Amounts deferred are subject to FICA and FUTA taxes but not current income tax.
  • Employee's elective contributions are limited to $12,0002 per year (2003).3

Early Withdrawal
  • A 10% penalty generally applies if withdrawals are made before age 59 1/2.
  • Some exceptions to the 10% penalty are available.
  • Employee elective contributions can be withdrawn for financial hardship.4

Early Withdrawal
  • A 10% penalty generally applies if withdrawals are made before age 59 1/2.
  • Some exceptions to the 10% penalty are available.
  • Employee elective contributions can be withdrawn for financial hardship.4

Retirement
  • Distributions must begin by specified date.5
  • Funds may be distributed as a lump sum or periodic payments.
  • Earnings + deductible contributions are taxed as ordinary income in the year received.

Retirement
  • Distributions must begin by specified date.7
  • Funds may be distributed as a lump sum or periodic payments.
  • Earnings + deductible contributions are taxed as ordinary income in the year received.

Death
  • Value of account is included in owner's gross estate.
  • Proceeds can pass to surviving spouse, with payments over the survivor's lifetime.
  • Income and estate taxes can severely reduce funds left to nonspousal heirs.

Death
  • Value of account is included in owner's gross estate.
  • Proceeds can pass to surviving spouse, with payments over the survivor's lifetime.
  • Income and estate taxes can severely reduce funds left to nonspousal heirs.
1The total contribution from both employer and employee may not exceed 25% of covered payroll, including participant deferrals, employer matching contributions and employer discretionary contributions.
2In 2004, this limit will be $13,000. Catch-up provisions are available to those age 50 and older.
3For 2003, the alocation total of employer contributions and employee deferrals to a participant's account may not exceed the lesser of 100% of compensation or $40,000 per year.
4If provided for by the plan. Under Treasury regulations, financial hardship is defined as "immediate and heavy financial need where funds are not reasonably available from other sources."
5Except for more than 5% owners, distributions must begin by the later of April 1 of (a) the year following the year in which the participant reaches age 70 1/2, or (b) the year following the year in which the participant retires.
6If there are employer contributions, the arrangement must generally satisfy the minimum participation requirements as well as the nondiscrimination rules applicable to employer-sponsored qualified plans.
7Withdrawals must begin in the later of the calendar year in which the taxpayer becomes age 70 1/2, or, the calendar year in which the employee actually retires. The first distribution may be delayed until April 1 of the following year. If deferred, two distributions will be required in that year.

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