At first glance, the 401(k) and 403(b) retirement programs look remarkably similar. Both plans allow participants to set aside money for retirement on a pre-tax basis. Both plans take their names from the relevant tax code governing them. Both plans, when managed Foolishly, will provide participants with significant sums of money for retirement. End of story? Not quite. While the programs seem remarkably similar on the surface, there are significant differences.

Who is eligible to contribute to a 403(b)?
The biggest difference between the two plans is eligibility. While the 401(k) covers private-sector workers, only employees of public schools and certain tax-exempt organizations -- as determined by good old Section 501(c)(3) of the Internal Revenue Code -- can participate in a 403(b) plan.

A qualified employer, in the eyes of the IRS, is an organization that is "organized and operated exclusively for religious, charitable, scientific, public-safety testing, literary, or educational purposes." These types of institutions include K-12 public schools, colleges, universities, hospitals, libraries, philanthropic organizations, and churches.

If your employer is uncertain about its status, it can contact the IRS outreach program. See IRS Publication 571, which covers the 403(b), too.

What investment options are available to 403(b) participants?
Unlike the 401(k), 403(b) participants cannot invest in individual stocks. Instead, their choices are:

Annuity and variable annuity contracts with insurance companies.
A custodial account made up of mutual funds. This is known as a 403(b)(7).
Retirement income accounts for churches.
How does a 403(b) work?
Participants set aside money on a pre-tax basis through a salary reduction agreement with their employer. The money is then directed to a financial institution selected by the employer. Like the 401(k), the money grows tax-deferred until retirement. It is taxed as ordinary income when withdrawn.

Are 403(b) participants limited to the vendors offered by their employers?
Yes and no. How's that for an election year answer? Generally, 403(b) participants can only contribute to the vendors offered or sponsored by their employers. In many cases, especially at K-12 schools, these choices are really no choice at all.

It's not uncommon for teachers to be limited to annuity products, with no direct access to mutual funds. Why should this matter? Financial planners are nearly unanimous in their aversion to annuity products within retirement plans. In addition to the higher fees, financial planners argue that it is redundant to put a tax-deferred investment (an annuity) into a tax-deferred plan -- a 403(b). Furthermore, many annuity products contain dubious exit clauses and penalties.

If you don't like your employer's offerings, there are several courses of action. The first is a frontal assault. Simply ask your employer to begin offering better choices. Enlist co-workers, and point out the differences in fees and performance. Back it up with Foolish research.

If that doesn't work, 403(b) participants can perform something called an "asset transfer" into the financial institution of their choice. The utmost caution is urged with this course of action. In theory, an asset transfer should be as simple as transferring an IRA from one financial institution to another. In practice, it rarely is.

One problem is that most annuity investments contain stiff penalties for early withdrawal. And, it's not uncommon for these charges to be in place for seven years. What is a Fool to do? Transfer only money that has been invested past the penalty phase. As new money passes the penalty threshold, transfer it.

A third, decidedly Foolish course of action has emerged that avoids exit fees and penalty phases. From your employer's list of approved vendors, find a financial institution offering a money-market account. Direct your 403(b) money first into this money-market account. Then periodically (every three to six months) perform an asset transfer (as described above) from the money-market account of the approved vendor to the financial institution of your choice (Fidelity, Janus, Vanguard, etc.).

Typically, money-market accounts charge few, if any, surrender fees -- so, you don't have to worry about penalties. Of course, there may be exceptions and limitations. The financial institution you wish to transfer your 403(b) money into should be able to provide guidance on this. While this route takes time and paperwork, it does allow you to invest in the financial institutions of your choice without the worry of penalty.

How much can be contributed annually to a 403(b)?
Generally, the maximum contribution for tax year 2000 is $10,500 or 20% of salary, whichever is less. Factors that play a role in determining the MEA (maximum exclusion allowance) include: salary, years of service with current employer, and prior tax-deferred contributions by the employee and the employer. As with the asset transfer, your financial institution should be able to provide guidance in calculating MEA totals.

What is the special "catch-up clause" in a 403(b)?
Ever wish you could have a financial do-over? In a way, the 403(b) affords this opportunity. If you haven't maxed-out contributions in previous years, a special "catch-up" provision in the 403(b) allows you to increase your annual contribution by $3,000 more than the current $10,500 limit. To qualify you must have completed at least 15 years of service with the same employer (years of service need not be consecutive). Contributions made under this catch-up provision cannot exceed $3,000 per year, up to a $15,000 lifetime maximum (under current rules). Consulting a tax professional before participating in this provision is recommended.

Why is the 403(b) often called a TSA or TDA?
When the 403(b) was created in 1958, participants could only invest in annuity products, so the name Tax-Sheltered Annuity (TSA) or Tax-Deferred Annuity (TDA) took root. Despite the fact that Congress granted 403(b) participants mutual fund privileges in 1974, the TSA/TDA name remains very common today.

Can a 403(b) be rolled into an IRA?
Yes. This can occur when the participant:

separates from service (job change),
becomes disabled

A word of caution. While the IRA has more investment flexibility (stocks), it does have a few drawbacks. Unlike a 403(b), you can't borrow money from an IRA. Plus, asset protection (from creditors, lawsuits, etc.) with an IRA is not as strong in some states. If you're satisfied with your current 403(b) plan, the most Foolish course of action may be to just leave it alone. Note: You are permitted to roll one 403(b) plan into another. But, you may not roll an IRA into a 403(b).

What are the options for a 403(b) when switching jobs?

Move the money into your new employer's 403(b) plan. (Note, a 403(b) cannot be rolled into a 401(k) and vice versa.)
Roll it into an IRA as mentioned above.
Leave it where it is, especially if you like your investment choices. If the balance is below $5,000 some employers require you to move the money. Check with your employer.
Take a lump some payment. Beware! This is not Foolish at all. This will trigger all kinds of fees and penalties, and worse, ridicule and scorn from your Foolish friends.

When can 403(b) money be accessed without penalty?
Generally, penalty-free distribution from a 403(b) cannot occur until the

Reaches age 59 1/2
Separates from service (and must be retired)
Becomes disabled
Through a loan (some investment companies allow this, some don't)
Suffers financial hardship