Your First Job: Deciphering Those Retirement Plan Options

401(k), 403(b), 457(b), Roth.

You’re starting your job soon and you’re looking through the employee benefits package. The retirement savings section is likely to have any one of these abbreviations. What the heck?!

Don’t ignore them - they are just for you!

High-level: The government wants people like us to save for our retirement because we are all better off if we can support ourselves when we are old and not have to rely on government support. Therefore, the government (because it can) created incentives to give us reasons to save for our future “old” selves - aka by lowering our tax bill.

In this post, I’m going to address some common types of retirement accounts and what they mean. (It’s not possible to cover everything in one post so if your employer offers something different - not to worry! Let me know and I can cover it in the future.)

All of these plans offer one of two things: 1) a lower tax bill now for contributing money to one of these retirement accounts, aka “pre-tax”, or 2) a lower tax bill later by putting money into one of these accounts and taking it out tax-free later in retirement, aka “after tax” or “Roth”.

This sounds sweet! But.

Of course there are rules to how and when and who can do this because the government still needs its tax income. For this article, I’ll focus on the pre-tax options (Roth options to come!). Here’s the breakdown.

401(k): Generally offered by private sector companies. Up to $22,500 per year (in 2023!) that you tell your employer to save for you (aka, “please put 15% of each of my paychecks into this new 401(k) account you’ll set up for me automatically”.) It’s pre-tax (let’s ignore any other Roth options for the moment): you do not pay taxes *today* on any money that you defer into this account through your employer. So if you make $80k annually and contribute $10k into your 401(k), come tax time, you will only have paid taxes on $70k.

403(b): Generally offered to private nonprofit employees and government workers, including public school employees. Similar rules to 401(k): can contribute up to $22,500 per year that you tell your employer to save for you (aka, “please put 15% of each of my paychecks into this new 401(k) account you’ll set up for me automatically”.) Also pre-tax.

457(b): Offered to state and local government employees. Similar to 401(k) and 403(b), but has its own $22,500 annual contribution limit (for 2023).

Important things to know strategically:

• These tax breaks for saving for retirement don’t come without some catches. I’m greatly simplifying here. For example, you can’t take money out of these plans until you reach a certain age limit or meet other criteria without penalty. The 457(b) is the least strict of these plans in this regard because you can take out money after you leave that company.

• While most employers typically only offer one type, some employers like a UC Berkeley can offer multiple. 

• The $22,500 is an annual limit regardless of however many different places you work; however, the 457(b) plan limit is its own separate thing. So while you cannot contribute $22,500 to a 401(k) and another $22,500 to a 403(b) in the same year, you can contribute both $22,500 to a 403(b) AND another $22,500 to a 457.

• You’ll pay taxes on the amounts you withdraw from these pre-tax plans in retirement. That’s when the government gets paid back for allowing you to defer your taxes on the money in those accounts during your working years.

• Some employers offer a “Roth” option for their 401(k) or 403(b) plans (and it’s a completely separate and totally different thing from a Roth IRA!). This changes your contribution to be after-tax. So while you’re still paying taxes now on what you put in, you won’t have to pay taxes later. These Roth 401(k) and Roth 403(b) options still allow you to put in the same annual limit, up to $22,500.

Of course - the government wants to get its tax money eventually so while you can’t take money out from your pre-tax retirement accounts (except in certain cases) before you’re at that future “old” you, you generally have to start taking money out when you get to age 72 - they’re called “required minimum distributions”. Ok, fine, I guess I’ll take my money. ;)

*Using 2023 numbers.

Need help deciphering what options and retirement savings strategy is best for you? Schedule a free 15-minute intro call here.

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