403(b) vs 401(k): Comparing retirement plans for non-profits


By Barbara A. Friedberg

Employers considering offering a retirement plan for their employees are faced with multiple choices. Specifically, tax-exempt, nonprofit organizations have a choice between offering a 403(b), a 401(k), or both. So, what exactly is the difference between a 403(b) and a 401k? This article breaks down the differences, pros and cons, and leaves the employer with some guidance to help make a decision.

Which organizations are eligible for 403(b) plans?

According to the IRS, a 403(b) plan, or tax-sheltered annuity (TSA), differs from a 401(k) in that it can only be offered by public schools and certain tax-exempt organizations, such as:

  • An entity created under 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 501(c)(3) institution which might include a not-for profit university, religious organization or social service agency

For example, the organization might be operated for these purposes; religion, education, charity, science, literacy, preventing cruelty to children or animals, and more. The eligible organization will typically be structured as a corporation, community chest, fund, or foundation. In general, an individual, partnership, or for-profit corporation won’t qualify for a 403(b).

Who can offer a 401(k)?

The 401(k) plan has greater latitude for employers and is offered widely across the United States, particularly at most large for-profit companies. Even many nonprofit entities may choose to offer a 401(k). These nonprofits are also eligible to present their employees with both a 401(k) and a 403(b) retirement plan option. In sum, almost any type of company may offer a 401(k) plan.

Now that it’s clear which types of employers qualify for the 403(b), 401(k), or both, you'll have to decide which option is the best fit for you and your employees. Before you make a decision as an employer, here is additional information to guide the process. Although there are similarities between the plans, they are not identical.

401(k) and 403(b): Similarities

Here's what they have in common:

  • In 2020 and 2021, the maximum annual contribution is $19,500.

  • The additional catch-up contribution for employees over age 50 is $6,500, for a total allowable contribution of $26,000.

  • All company employees should be eligible to participate.

  • The total employee elective deferral plus Roth IRA and after-tax contributions is limited to the lesser of $57,000 or 100% of the employee’s contributions. This limit includes employer contributions as well. (403(b) participants have additional rules if they own 50% of another company which also has a 401(k) plan.)

  • Both plans, the 401(k) and 403(b) may be terminated according to pre-determined plan governing rules.

  • Both types of plans allow for a Roth (after-tax) option.

More information on the Roth vs. traditional distinction:

401(k) vs 403(b): Breakdown of Differences

  401(k) plan 403(b) plan
Investment options Any investment option is allowed according to the Employee Retirement Income Security Act of 1974 (ERISA). Includes: mutual funds, annuity contracts, and individually managed portfolios. Annuity contracts or custodial accounts invested in mutual funds. (Churches may have additional options.)
15-year service catch-up Not available Allowed. If over age 50, must be applied before $6,500 over-age 50 catch-up is applied.
Plan 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 ½ or upon disability.
Applicability of ERISA In general, subject to ERISA. Depends upon the circumstances and construction of the plan.
Transfers across investment alternatives within the plan Allowed (subject to any plan documents). Allowed in most cases, if information-sharing agreements are in place and are within plan parameters.

Nonprofit retirement plan cost considerations

403(b)s have historically been notorious for excessive fees. A recent feature in the New York Times explained, "The 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." This, in combination with the fact that many organizations don't have a lot of options when it comes to 403(b) providers, means that many of the current 403(b) plans currently in existence offer employees a confusing set of high-fee funds.

Not all 403(b) plans have to be bad, and at Human Interest, we pride ourselves on offering a 403(b) that is on par with our 401(k) offerings, in the best interest of organizations and employees who do a lot of good for the world.

Related articles:

How to decide: 401(k) vs. 403(b)

401(k) pros: The main benefit of a 401(k) over a 403(b) is flexibility. Would your organization potentially change in the future from a 501(c)(3) to a C-Corp or S-Corp? If so, a 401(k) would be able to stay with you during that transition, whereas a 403(b) would not.

403(b) pros: 403(b)s have slightly easier compliance testing requirements but these are often dependent on the provider.

Governmental, non-ERISA organizations would receive a lot of additional benefits with a 403(b) compared to a 401(k) -- for instance, they can double their deferrals, put in $38,000 on a pre-tax basis, etc. However, if you are not a governmental entity, it’s likely an ERISA plan, so a 403(b) becomes even more similar to a 401(k).

Human Interest serves several nonprofit organizations and we offer both 401(k)s and 403(b)s at the same price. If you need any more information to decide between the two or have any specific questions about your organization's needs, please click here to contact us and we'd be happy to help.

Veteran portfolio manager, expert investor, and former university finance instructor. She has authored 3 money/investing books. Friedberg also owns the financial websites RoboAdvisorPros.com and BarbaraFriedbergPersonalFinance.com.

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