Walnut Hill Advisors, LLC

These plans are often lumped together as workplace plans because each is offered through a company as a benefit. Each of these plans typically offers an opportunity for an employee to contribute to their account with pre-tax money. But there are differences among these plans.

401(k)’s were born out of the original profit sharing plan, which originally was a plan to which only employers contributed for their employees (as a ‘share’ of profits). Eventually, line 401(k) in the Internal Revenue Code (IRC) was written to allow employees to defer salary into these plans also. Interestingly, due to financial difficulties, it has morphed into a situation where most of the retirement plan contributions are deferrals and that ‘profit sharing’ has nearly disappeared!

403(b)’s are retirement plans that only non profit organizations/employers can set up. These are purely salary deferral plans with no profit sharing element. The idea is that number one, non-profits don’t earn a ‘profit,’ and number 2, they need a plan to offer employees that was not too administratively burdensome nor costly. I know I can hear some of my clients say “Chris, I work at a non-profit and I get a match, why do you say that 403(b)’s for non-profits only allow salary deferrals?” This is true – some non-profits offer a match/employer contribution but it is done differently. Either the employer also maintains a 401(a) plan (there’s that IRC line 401 again) alongside the 403(b) as many universities do, or the non-profit sponsors a 401(k) – something they were allowed to do some years back due to the fact that non-profits couldn’t offer a match through their 403(b).

457 Plans are deferred compensation plans offered through municipal governments. They have some unique rules, including some that changed recently regarding Roth conversions which make them more on par with 401(k)’s. They also had some unique benefits in the past but recent legislation has worked to make 401k-403b-457 plans more consistent with each other. The original idea – that I am guessing – was that municipal employees earned less than private sector employees and needed some special privileges. However, today, that perspective has changed with the average government employee earning much more in total compensation than private sector employees on average.

Bottom line – the generous contribution limits, especially from the perspective of an average earning American, make these workplace plans a handy tool in tax planning and retirement planning for most people. Recent worry about deficits, national debt, and the effects on future tax rates make some advisors caution against putting too much into pre-tax plans and to recommend that more go into a tax-free plan like the Roth 401(k)/IRA. This question, along with many others regarding the benefits to you of using these plans and how to use them in your personal comprehensive financial plan, is best answered after you perform a full analysis of your situation and then intelligent recommendations can be made.

For more information on planning ideas, see our list of recent financial articles including “Individuals Must Create Their Own Pensions, But How” and “Roth Conversion – a Good Idea?” Also, make sure you don’t miss a thing. Become a member of our Insiders’ Club and receive once a week updates on educational financial articles that afect your net worth, along with private invitations to free workshops and events on critical financial topics. So join us – what do you have to lose?