Considerations for Nonprofit Organizations
This article was co-authored by Erika Young, director of employer plan services at Wipfli Hewins Investment Advisors.
Many employees of nonprofits are passionate about their jobs and the purpose they serve in making a positive, societal impact. However, this satisfaction may be outweighed by lack of financial support from their employers, particularly in the realm of retirement planning.
According to a recent study from the TIAA-CREF Institute, roughly 45 percent of nonprofit employees reported they felt unsure of their ability to plan for a financially secure retirement.1 To keep top talent coming into their organizations, it’s important for leaders of nonprofits to dispel their employees’ retirement insecurities with valuable, secure retirement plans.
Typically, 401(k) and 403(b) plans are the two most common retirement savings vehicles for nonprofit organizations. Before 2009, there were significant advantages for nonprofit organizations to sponsor a 403(b) plan in place of a 401(k) plan. However, in light of the changes made by the Internal Revenue Service (IRS) to the 403(b) plan rules, the differences between the two are now much narrower. In fact, a 401(k) plan may actually be a better option for some nonprofits.
Here’s a breakdown of the plans, including their similarities and differences:
How Are They Similar?
Structurally, 401(k) and 403(b) plans are comparable. Let’s start with some of the basic similarities:
— 403(b) plans are now subject to the same Form 5500 filing requirements as 401(k) plans, under the Employee Retirement Income Security Act of 1974 (ERISA).
— Both plans may be subject to the large retirement plan audit requirement.
— Basic employee contribution limits are the same for both plans.
— Catch-up contribution limits are essentially the same for both plans; however, 403(b) plans offer “special” catch-up contributions for long-term employees with 15 years of service.
— Both plans allow for non-elective and employer matching contributions.
— Several features are allowed in both plans, including Roth contributions, Safe Harbor provisions, vesting schedules for employer contributions, loans, rollovers and more.
How Are They Different?
Now, the important part: there are distinct differences between the two types of plans, specifically with regard to participant eligibility and reporting requirements for employers.
The most notable difference between 401(k) and 403(b) plans is the former: participant eligibility requirements. A 403(b) plan is generally subject to the universal availability rule, which requires that all employees be eligible to defer into the plan on their first day of employment (with a few exceptions). In a 401(k) plan, requirements may be imposed before employees are rendered eligible for the plan. For example, the company may require that an employee complete one year of service with 1,000 hours before becoming eligible to participate in the plan.
The universal availability rule may prove to be problematic for some 403(b) plans, particularly those with a large number of part-time employees or high turnover.
Under this rule, all 403(b) plans with more than 100 participants (or more than 120 participants, if the organization filed as a small employer the previous year) must undergo a large plan audit. By terminating their 403(b) plan and starting a 401(k) plan with eligibility requirements, some nonprofits could drop below the large plan audit requirements, which could save them a lot of time and money.
The compliance-testing requirement is the second major difference between the two types of plans. Since 403(b) plans require universal availability, plan sponsors are not required to have non-discrimination testing completed on employee contributions.
This can be a favorable feature to some nonprofits, particularly if there is low participation in the plan, and there are a few highly-compensated employees who want to contribute the maximum amount annually.
Conversely, a 401(k) plan is required to complete non-discrimination testing annually (unless it is a Safe Harbor plan). The issue is that annual non-discrimination testing can limit the average deferral percentage for employees that make more than $115,000 per year to two percent above the average rate of “rank-and-file employees”. In a small organization with very few highly-compensated employees, this requirement can often limit the amount that these individuals can contribute to the plan. If your organization encounters this situation, a 403(b) plan may be a better fit.
At the end of the day, keep in mind that every nonprofit is different — what is more suitable for one organization may not be optimal for you or your employees. Therefore, it is important to work with a qualified retirement plan specialist, one who understands the subtle differences between the two types of plans and can help you choose and set up the option that will benefit your specific situation.