Traditionally, 403(b) plans have been the qualified retirement plan of choice for not-for-profits. These plans were established for the exclusive benefit of tax-exempt organizations. However, a not-for-profit now have other options as well. Even if you continue to prefer a 403(b) plan, as many nonprofits still do, it pays to review and weigh the benefits of other types of accounts.
Four Types
A not-for-profit generally may choose from the following four plans:
1. 403(b). The 403(b) plan is comparable to the better-known 401(k) plan. Contributions are made on a pretax basis through paycheck deductions. They can grow and compound tax-free until the account holder makes withdrawals. Distributions taken by participants age 59½ and older typically are taxed at ordinary income rates. Your organization may also choose to offer employees a Roth-type 403(b) plan. With these plans, contributions are taxable, but distributions are tax-free.
For 2022, the individual limit on 403(b) contributions is $20,500 ($27,000 for those age 50 or older). Furthermore, staffers who have worked for your organization for at least 15 years can contribute an additional $3,000 a year for five years if they’ve contributed an average of less than $5,000 per year previously. This specific “catch-up” contribution is unique to 403(b) plans.
Your nonprofit can also make contributions to 403(b) accounts. Loans and hardship distributions may be possible if certain requirements are met.
2. 401(k). This for-profit standard can also be used by not-for-profit organizations. As with 403(b) plans, participants may contribute up to $20,500 ($27,000 for those age 50 or older) in 2022. Participant accounts may also receive matching contributions from employers up to a certain percentage of compensation.
As with 403(b) plans, 401(k) contributions can grow tax-deferred until they are withdrawn. Distributions by participants age 59½ and older are taxed at ordinary income rates. And a 401(k) plan can be set up as a Roth-type account that accepts after-tax dollars but provides tax-free withdrawals. Loans and hardship distributions may be permitted if certain requirements are met.
3. Savings Incentive Match Plan for Employees (SIMPLE). As the name implies, 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 relatively rigid structure. For example, these plans don’t permit loans or hardship distributions. Nor can SIMPLE plans be set up as Roth-type accounts.
For 2022, SIMPLE plan participants can contribute up to $14,000 ($17,000 for those age 50 or older). A 10% early withdrawal penalty applies to most qualified plan distributions (for example, from 403(b) and 401(k) accounts) made before age 59½, unless a special exception applies. However, the penalty is 25% for early distributions from a SIMPLE plan if it’s taken within two years of establishing the account.
4. Payroll deduction IRAs. These are even simpler 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.
Compare Pros and Cons
Other options used in the for-profit sector, such as defined benefit plans, are available to a not-for-profit. However, they’re not common. And, in fact, most nonprofits choose 403(b) plans. The following advantages weigh in their favor:
No ERISA requirements. Like government agencies and school systems, most nonprofits don’t have to follow Employee Retirement Income Security Act (ERISA) rules, so administration tends to be less burdensome. For example, administrators of most 403(b) plans aren’t required to perform annual nondiscrimination testing. This can also benefit highly compensated employees.
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.
Additional catch-up provision. The $3,000 catch-up provision can help beef up the nest eggs of staffers who haven’t steadily contributed to a retirement account. Employees of the following types of organizations are eligible to make these contributions:
- Public school systems,
- Hospitals,
- Home health service agencies,
- Health and welfare service agencies,
- Religious congregations, and
- Conventions or associations of churches.
Broad eligibility. Generally, not-for-profit employees can participate in an employer’s 403(b) plan immediately. Certain restrictions usually apply to 401(k) eligibility — for example, workers must be at least age 21 to open an account.
On the other hand, 401(k)s have certain benefits over 403(b)s. For one, there are many more 401(k) plan providers to choose from. Typically, this competition results in lower administrative fees. Participants also generally have greater investment options with a 401(k), such as individual stocks, bonds, low-expense mutual funds and exchange traded funds.
Growing and Evolving
Even if you currently offer employees a 403(b) plan, at least consider other options as your organization grows and evolves. You might want to survey workers to learn what they value in a retirement plan — and what they feel your current plans lacks. Also consult professional financial and benefits advisors who can help you evaluate features and costs.
Please contact Julia Lafferty via our online contact form for more information.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.
