Employers wanting to offer a retirement plan for their employees have many choices. For tax-exempt, non-profit organizations one such choice is whether to offer a 401(k), a 403(b), or both. This post touches on the differences and pros and cons, and leaves employers with some guidance to help make a decision.
Who can offer a 403(b) plan?
The IRS says a 403(b) plan, or tax-sheltered annuity (TSA), can be offered by public schools, churches, and certain tax-exempt organizations. Here's a more complete list provided by the IRS:
- An entity created under the section 501(c)(3) of the Internal Revenue Code
- Public school systems
- Cooperative hospital service organizations
- Uniformed Services University of the Health Sciences (USUHS)
- Public school systems organized by Native American tribal governments
- Certain ministers
- Any 401(c)(3) institution which might include a not-for profit university, religious organization or social service agency
Eligible organizations are typically structured as corporations, community chests, funds or foundations. Generally speaking, sole proprietorships, partnerships and for-profit corporations won't qualify for a 403(b).
*Tip: There are over 23,000 registered 501(c)(3) organizations in the state of Oregon. Use this tool to lookup any registered 501(c)(3) organization.
Who can offer a 401(k) plan?
Unlike 403(b) plans, the IRS allows both for-profit and non-profit entities to offer a 401(k) plan. In fact, with the exception of governmental entities, virtually any organization can establish a 401(k) plan. Non-profits are even allowed to offer both a 401(k) plan and a 403(b) plan, although this arrangement is not common.
Similarities between 403(b) and 401(k)
- An employee's maximum annual contribution in both plans is $18,000*
- Employees over the age of 50 are allowed an additional catch-up contribution of $6,000*
- Total contributions to an employees retirement account are capped at $54,000 in 2017, including employer contributions
- Both plans can be terminated according to pre-determined plan governing rules
- Both plans allow for Roth contributions
Contrasts between 403(b) and 401(k)
| CONTRAST | 401(k) | 403(b) |
|---|---|---|
| Investment Options | Any investment option is allowed according to the Employee Retirement Income Security Act of 1974 (ERISA). Includes: mutual funds, annuity contracts, individual securities, and managed portfolios. | Annuity contracts or custodial accounts invested in mutual funds. Churches may have additional options. |
| Eligible Employees | All or a sub-set of the employer's employees. | All employees must be eligible for elective deferrals (including Roth contributions) if any are eligible, with certain limited exclusions permitted. |
| 15-Year Service Catch-up | Not permitted | Permitted but must be applied first if aged 50 catch-up also applies |
| Actual deferral percentage (ADP) test of elective deferrals (including Roth contributions) | Generally required | Not applicable |
| Hardship Withdrawals | Allowed, after a specified number of years, certain age, disability or other predetermined event. | Allowed from annuity accounts, after a specified number of years, certain age, disability or other predetermined event. Hardship withdrawals from custodial accounts allowed only at age 59 1/2 or upon disability. |
| Applicability of ERISA | Generally subject to ERISA | Plan with only elective deferrals (including Roth contributions) not subject to ERISA under certain conditions. Matching contributions, even if made to a plan other than the 403(b), or other employer contributions to the 403(b) plan, generally will cause the 403(b) plan to be subject to ERISA. |
403(b) plans have been getting some unfavorable press recently due to their reputation for excessive cost to participants and more lenient regulations. A recent article in The New York Times brought these issues to the forefront in the public domain.
“403(b) accounts that many workers contribute to are not subject to the more stringent federal rules and consumer protections that apply to 401(k) plans.”
But not all 403(b) plans are bad. Organizations that perform their due diligence, work with long tenured retirement plan experts, and put the best interests of their employees first, will find that both 403(b) and 401(k) plans can be successful vehicles for accumulating retirement savings.