401(k) or 403(b) plan? Nonprofits have a choice

Linda J. Kramer, CPA
Manager, Employee Benefit Services

Certain nonprofit organizations have a choice that corporations don’t have in selecting retirement plans for their employees. But there are pluses and minuses to both types of plans, and management and employees alike should be aware of what they are getting.

Until 1996, nonprofit 501(c)(3) organizations could only offer 403(b) plans to their employees. Similar to the more well-known 401(k) plan, the 403(b) offers employees the ability to save for retirement through payroll deductions that are sometimes matched by their employers.

In 1996, the law changed allowing nonprofit organizations to choose either the 403(b) or 401(k) plan for their employees.
Here are some key differences between the two types of plans:

• Unlike 401(k) plans, 403(b) plans are not subject to nondiscrimination testing requirement for salary deferrals. The rules that apply to 401(k) plans sometimes require salary contributions to be returned to highly-compensated participants due to the results of nondiscrimination testing. This cannot happen with 403(b) plans.
• Annual limits are the same for both a 403(b) plan and a 401(k) plan, except that the 403(b) plan may elect an additional form of catch-up contribution, giving participants more flexibility.
• 403(b) plans must follow the “universal availability” rule for eligibility to defer salary, meaning that if an employer permits one employee to defer salary into a 403(b) plan, they must extend this offer to all employees. However, some employees may be excluded, including:

1. Employees who will contribute $200 annually or less
   Employees who participate in a 401(k) or 457 plan, or in another 403(b) plan
2. Non-resident aliens
3. Employees who normally work less than 20 hours per week
4. Students who work for a school where they are pursuing study and are, therefore, exempt from FICA withholding

• In organizations with 403(b) plans, for the most part, participants are allowed to defer salary immediately upon hire and regardless of age, whereas 401(k) plans typically have a waiting period and age requirement.
• All plans must have written plan documents. 403(b) plans do not have the option to use pre-approved prototype documents that 401(k) plans may use; however, the IRS has hinted that this may change in the near future.
• 401(k) plans have a wide-range of investment options. 403(b) plans are restricted to custodial accounts invested in mutual funds or annuity contracts issued by insurance companies.

Until the 2009 plan year, ERISA 403(b) plans were not subject to the annual audit requirement that 401(k) plans were subject to. This provided a strong incentive for nonprofit organizations to stick with 403(b) plans. However, ERISA 403(b) plans with 100 or more participants are now subject to the audit requirement.

Some nonprofit organizations have established 401(k) plans in recent years, as the 401(k) is more well-known to their employees.

If your organization is looking to switch from a 403(b) plan to a 401(k) plan, here are some considerations to keep in mind:

• If your ERISA 403(b) plan has 100 or more participants, the audit requirement still stands for the plan until all participants have transitioned to the 401(k), or the participant count at the beginning of the plan year is reduced below 100.
• Some 403(b) plans cannot be terminated due to legal requirements. If your organization is determined to offer a 401(k) plan, it may have to maintain and administer both plans in order to fulfill its legal obligation to the 403(b) participants.

Please call Linda Kramer, CPA, or Frank Ardito, CPA, at 617-696-8900 with any questions about retirement plan services, or visit our web site for a detailed list of our retirement plan services.