Differences between 403(b)s and 457(b)s you will want to know

If you’re here, you probably are looking at your benefits elections and scratching your head over what the various strings of random-seeming numbers and letters mean and how best to use them to fund your retirement. After you read this one, if you haven’t already be sure to check out my guide to New Job Benefit Elections for Academics for info on lots of related decisions for new jobs or for annual benefits elections.

The Basics

Let’s start simply by defining terms.

403(b)s

403(b): This is probably the most common tax-protected retirement account for academics. Think of it as the non-profit equivalent of a 401(k), if you know what that is. If you don’t, just know that it’s a retirement account that your employer sets up for you that offers significant tax advantages.

You can contribute to this account on a pre-tax basis (meaning you don’t pay taxes until you withdraw funds in retirement, allowing your pre-tax money to grow until then), or sometimes you have the option to contribute to it on a post-tax basis (meaning you pay taxes on it now but never again, including on your long-term capital gains), or a mixture of the two. (See Should I contribute pre-tax or post-tax? when I get around to writing it.)

There is an annual employee contribution limit in 2023 of $22,500 (+$7,500 if you’re age 50+). This limit does not include any matching funds your employer contributes. (The limit on total contributions by employee and employer is $66,000 in 2023, but I’m guessing few academics run into this restriction.)

In exchange for these significant tax benefits, there are a few restrictions:

1. While you’re still employed by the employer who setup the account, you can’t withdraw from 403(b)s without a 10% penalty before age 59.5.
2. However there are some exceptions when you meet one of the following conditions: separation from service, retirement, financial hardship, disability, or of course death.
3. Before age 59.5, you can borrow against these funds, for instance to fund a house down payment, major renovation, or significant medical expense, up to 50% of your vested account balance or $50,000, whichever is smaller.
4. You can access these funds early without a 10% penalty if you leave your job at age 55 or later.

457(b)s

These accounts are very similar to 403(b)s from the employee’s perspective. Like a 403(b), 457(b)s are for non-profit institutions, offer significant tax advantages, can be configured to allow pre-tax, post-tax, or both contributions, and are employer-sponsored. The employee contribution limits are identical (currently $22,500 as of 2023).

1. However, the rules governing distributions from these accounts differ. You can withdraw from your 457(b) immediately upon leaving service with the employer that set it up, regardless of age. This is a major tax advantage for any who wish to retire early.
2. The catchup provisions also differ. Starting in 2025 thanks to Secure Act 2.0’s passage, 457(b) participants age 60-63 can contribute $10,000 in catchup provisions. If you’re 64-66, you can contribute twice the limit ($45,000).
3. If your employer offers a match on your 457(b), it counts toward the annual employee contribution limit, unlike a 403(b).

Which Should You Use?

If you have access to both of these retirement accounts, which should you use?

The optimal scenario, of course, is that you maximize both. Any tax protection you get on your retirement accounts can yield huge returns. This is why you generally should max out all your tax-protected investment accounts before you put any money in a taxable brokerage.

Of course, that assumes that you have at least $45,000 in pre-tax salary to spare every year. I only was able to start doing this in the last couple years. Let’s say you can’t — which should you invest in first?

The answer comes down to a few very important details, I think:

1. If one account has a post-tax option and the other doesn’t: If you prefer post-tax contributions, I would prioritize whichever account offers them, all else equal.
2. If both accounts are pre-tax only: In this case, to me it comes down to whether you plan to seek employment elsewhere before retirement and/or plan to retire early. If you plan to leave for either reason before age 59.5, I would prioritize the 457(b) account first because it’s much easier to access after you leave your employer.