Nonprofits and 403(b) plans have traditionally gone together like peanut butter and jelly. 403(b) plans were established for the exclusive benefit of tax-exempt organizations and have long been the plan of choice for nonprofits. However, nonprofits now have other options to consider. Even if you prefer a 403(b) plan, as many nonprofits still do, it is worthwhile to review and weigh the benefits of other types of plans.
Four Types
Generally, a nonprofit has the four types of plans to choose from:
- 403(b). The 403(b) plan is similar to a 401(k) plan. Contributions can be made on a pretax basis through paycheck deductions. They can grow tax-free until the account holder makes withdrawals. Distributions taken by participants age 59½ and older typically are taxed at ordinary income rates. Alternatively, your organization may also choose to offer employees a Roth-type 403(b) plan meaning contributions are taxable, but distributions are tax-free.
Employer matching contributions can also be made to 403(b) accounts. Additionally, loans and hardship distributions may be possible if certain requirements are met.
- 401(k). This plan, commonly used by for-profit entities, can also be used by nonprofit organizations. Participant accounts may also receive matching contributions from employers up to a certain percentage of compensation.
As with 403(b) plans, employee contributions can be made pretax or after-tax (Roth) and the tax treatment of any distributions would be treated the same as under a 403(b) plan. Loans and hardship distributions may be permitted if certain requirements are met.
- Savings Incentive Match Plan for Employees (SIMPLE). SIMPLE plans are easy to administer and exempt from many of the strict testing and reporting requirements that apply to 401(k) and 403(b) plans. However, SIMPLEs rely on a rigid structure. For example, these plans don’t permit loans or hardship distributions, nor can they be set up as Roth-type accounts. SIMPLE plans also require employer contributions equal to a certain percentage of employee compensation.
Withdrawals from 403(b) and 401(k) accounts made before age 59 ½, unless a special exception applies, are subject to a 10% early withdrawal penalty. However, the penalty is 25% for early distributions from a SIMPLE plan if it’s taken within two years of establishing the account.
- Payroll Deduction IRAs. These are even easier than SIMPLEs. Employees establish IRAs for themselves, and your organization makes contributions on their behalf with payroll deductions. Of course, employees could set up their own automatic investment plan for an IRA. But by formalizing the process, you encourage staffers who might not otherwise save for retirement to start and maintain a good saving habit.
The chart below also compares the current 2022 contribution limits for each plan type.
| Contribution Type | 2022 Employee Contribution Limit |
| 403(b) | $20,500 |
| 403(b) Catch up | $3,000* |
| 401(k) | $20,500 |
| 401(k) and 403(b) Catch up | $6,500 (those age 50 and older) |
| SIMPLE | $14,000 |
| SIMPLE Catch up | $3,000 (those age 50 and older) |
| Payroll Deduction IRA | $6,000 |
| Payroll Deduction IRA Catch Up | $1,000 |
*Only if employed by an eligible organization (public school system, hospital, home health service agencies, health and welfare service agencies, religious congregations, conventions, or associations of churches) and has been employed by the organization for at least 15 years and contributed less than $5,000 per year previously.
Reviewing the Options
Nonprofits also have the option of using defined benefit plans; however, this is not common, and most nonprofits still choose 403(b) plans.
The following are key benefits of a 403(b):
Reduced ERISA requirements. Unlike 401(k) plans which are subject to many nondiscrimination tests each year, 403(b) plans don’t undergo quite the same level of scrutiny which can save plan administrators some headache. However, this doesn’t exclude a 403(b) plan from annual audit requirement.
Note: Even nonprofits that don’t automatically qualify for non-ERISA status may be able to avoid ERISA rules if they don’t provide employer contributions and have only “limited involvement” in the plan.
Universal Availability. One unique feature with 403(b) plans is that the plan is generally required to allow eligible employees participation in the plan upon date of hire (universal availability rule). Conversely, most 401(k) plans have certain service requirements that must be met before an employee can participate. This can also be a headache for some organizations.
On the other hand, there are certain benefits of a 401(k). For example, there are many more 401(k) plan providers to choose from and, with this competition, lower administrative fees are available. Participants also generally have greater investment options with a 401(k), such as individual stocks, bonds, low-expense mutual funds and exchange traded funds.
Evaluate Periodically
As your nonprofit experiences change and continues to grow, it is important to revisit these plan options to ensure you are offering the plan most suitable to your employees.
For additional information or guidance related to this article, contact Jovana Krajewski at jkrajewski@vlcpa.com or 800.887.0437.
