401k versus 403b

The main difference between a 401k and a 403b is the way the company providing the two types of retirement savings accounts is structured. 403b accounts are solely reserved for non profit organizations, which include not only charities but also schools, government organizations and churches. On the whole, the two types of accounts are very similar. Since a 403b is distributed from a company that cannot legally generate profit, however, the account has a few unique features.

403b Account Features

Mainly, a 403b account cannot provide any type of profit sharing or dividend to employees of the company. If they a company provided these options, then it would not legally qualify as a non profit organization in the future. Further, the company cannot own the accounts in any way. The sole responsibility of the company is to make deposits into the account in the amount agreed upon in the employee benefits package. Other than this simple task, the company has no control over the account. This means the company cannot limit withdrawals or loans out of the account like other companies do. However, the 403b account is still managed by a financial firm which can advise employees on the best way to avoid penalties and structure taxes correctly.

401k Account Features

Your employer owns the 401k account to some degree, meaning the employer can restrict you from taking loans or withdrawals from the account unless you apply and are approved to do so. Along the same line, the company can offer profit sharing, stock and dividend payments into the 401k account. Since the company is for-profit, it does not have to be concerned with losing any tax-exempt status by making this type of arrangement.

Which Account is Better?

Unfortunately, this is not truly a question you get to ask. Depending on where you work, your employer will make the choice for you. 401k accounts tend to be more profitable, but working for a for-profit organization tends to be more profitable in general than working for a non profit organization. If you do pursue a career with a non-profit, you will see other benefits. For example, choosing a low paying public service career can allow you to have student loans forgiven and even get special mortgages from the government that are cheaper than private options.

Changing Between Accounts

If you have either a 401k from an old job or a 403b from an old job, you have options to roll these funds over and get the most out of your account. It is always advisable to speak with a tax professional. You will be responsible to pay taxes on any profit that actually transfers into your pocket during a rollover between retirement accounts. As such, it is best to have the funds move from one account to the next without ever touching your personal bank account. That way you do not have to worry about any unintended profits that could be penalized not only by taxes but also by a 10% early withdrawal fee if you are not at least 59 1/2 years old.

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Will I Owe Taxes after a Pension Rollover?

If you change your pension structure in the middle of a tax year, you should be aware of any potential tax payments you may owe come April. Many people are surprised to learn they owe thousands of dollars when they change their tax structure. Failing to plan for this, and indeed failing to pay the taxes as you go instead of waiting for April, will leave you with a very large bill you cannot immediately pay.

When you Owe Taxes

There are two main types of taxes or penalties you may owe the Internal Revenue Service after a pension rollover. The first will occur if your new pension is taxed differently than your old pension. The second penalty will occur if you do not fully rollover the funds in time to your new account.

• Different tax structures: If your new pension structure has a different tax determination than your original, you may end up owing the difference. This generally occurs if you are switching from a 401k to an IRA or from a traditional structure into a Roth format.

  401k to IRA - With this consideration, you are moving from an account that used pre-taxed dollars to one that uses tax deductible contributions. As such, you will have to pay taxes on the withdrawal you make from your 401k, and then deduct those funds from your taxable income when they are fully-vested in your IRA. Thankfully, these two steps will largely balance each other out. This means you may owe just a few hundred dollars in the end. Your accountant can help you determine any remaining balance. If you are going in the opposite direction, from an IRA to a 401k, you will not typically owe any money because you have already paid taxes on the funds.

  Traditional to Roth - This model will typically leave you with a bigger tax bill. In particular, moving from a 401K to a Roth structure can be expensive. Your 401K was never taxed, but your funds must be taxed prior to deposit in your Roth 401K or Roth IRA. As such, you will have to pay the taxes on the principal and earnings at your current tax bracket when you move them to the Roth format. Thankfully, you will only pay these taxes once, and then you never owe taxes again on these funds.

• Withdrawal penalties: You have 60 days after withdrawing the funds from your original pension to place them in your new pension account. If you fail to do this within 60 days, you will be charged as if you withdrew the funds early, which is a 10% penalty. The best way to avoid this is to move the funds directly instead of receiving them yourself first.

Pay As You Go!

Most people forget we have a “pay-as-you-go” system for taxes. Each quarter, you will need to pay taxes you estimate to the IRS instead of waiting until April. Make sure to pay estimated taxes on the funds each quarter or you will be hit with a penalty come April.

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