LAST REVIEWED Apr 21 2021 17 MIN READ
By The Human Interest Team
Tax-exempt, nonprofit organizations often offer 403(b) retirement plans in lieu of different retirement account options such as a 401(k)s. And like a 401(k), there are many benefits for nonprofits to offer a retirement savings benefit and for their employees to take advantage of one. In this article, we’ll discuss what nonprofits need to know about 403(b)s.
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Learn more about 403(b)s in our guide. But, before we dive in let’s clarify…
What is a 403(b)?
A 403(b) is one of many types of retirement plans that can be offered through work. Usually offered by nonprofits, church organizations, and public education institutions, a 403(b) comes with tax advantages for people trying to save for retirement and a high annual contribution limit.
What’s the difference between a 403(b) and a 401(k)?
Both 403(b) and 401(k) plans are employer-sponsored retirement plans that can give you tax savings. Each account plan is named for the sections of the IRS code that explain their structure: 403(b) and 401(k), respectively. The key difference between 403(b) and 401(k) plans is the organizations that can sponsor them.
Nonprofit organizations or government employers can offer 403(b) plans. They can also offer 401(k)s, although this is less common.
Private, for-profit corporations offer 401(k) plans
There are also some structural differences between the two. Want to learn more about the other differences between a 401(k) and a 403(b)? Find out in our guide.
How to find the best 403(b)
What is the best 403(b) plan for nonprofits? It’s a question that will have a lasting impact on the financial future for nonprofits and their employees. But before you begin your search for the best 403(b) companies, you need to understand the features these 403(b) providers provide and how they will impact plan administration and how plan participants save. Here’s our guide on how to find the best 403(b) plans for nonprofits and their employees.
How to set up a 403(b) for your nonprofit
Helping their members to adequately prepare for retirement is an uphill struggle shared by many nonprofits as the staff consistently focuses on its core mission: helping others. Given the difficulties, many small- and midsize nonprofit organizations simply let their employees fend for themselves with individual retirement accounts at whatever brokerage firm they can find. But nonprofit workers, who are often underpaid, may put themselves at severe financial risk by not saving for retirement at all if they lack a workplace retirement plan.
Providing a workplace retirement savings plan for these nonprofit workers should become a high priority and one of the best solutions is to set up a 403(b). Here’s a guide on how to set up a 403(b) for your nonprofit.
Contribution limits for 403(b) retirement plans
If you have a 403(b) retirement plan, there are annual contribution limits that you must adhere to. For 2021, the total of your elective salary deferral contribution and your employer match amount cannot exceed $58,000 or $64,500 if you’re age 50+. Here are the contribution limits for 403(b) retirement plans.
Roth 403(b): After-tax option for nonprofits
Typically offered to nonprofit employees, government workers, and church employees, 403(b) plans are defined-contribution plans that allow participants to shelter money on a tax-deferred basis. For example, 403(b) plan holders can contribute up to $19,500 ($26,000 if age 50 and over) in 2020 and 2021 and start taking distributions at age 59 ½ (subject to a 10% early withdrawal penalty in most cases).
Another feature shared by 403(b) and 401(k) plans is the ability for plan holders to make contributions with after-tax dollars. This opens up one more option for retirement savers looking to maximize their tax-free withdrawals during retirement. Here’s what you need to know about Roth 403(b): after-tax options for nonprofits.
The SECURE Act: 5 changes affecting 403(b) plans
Typically, 403(b) plans are defined-contribution plans that allow participants to shelter money on a tax-deferred basis. Some nonprofits may be able to establish a Roth 403(b) plan or allow plan participants to make after-tax contributions.
In an effort to make it easier for American workers to save for retirement and for employers to set up and maintain workplace retirement plans, the House of Representatives has proposed the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act. While the media has focused on the effects of the SECURE Act on 401(k) plans, this proposed legislation includes several changes that will also affect the way that 403(b) plans operate. Given that in 2016, there were over 1.56 million nonprofits employing over 12.2 million Americans, that’s a lot of changing 403(b) plans. Here are 5 changes affecting 403(b) plans
401(a) vs. 403(b): What’s the difference?
Both 403(b) and 401(a) plans are employer-sponsored retirement plans that can give you tax savings. Each account plan is named for the sections of the IRS code that explain their structure: 403(b) and 401(a), respectively. One of the key differences between 403(b) and 401(a) plans comes down to plan design: a 403(b) typically offers annuity options from insurance providers, while a 401(a) usually facilitates mutual fund investments.
There are also some structural differences between the two. Want to learn more about the other differences between a 401(a) and a 403(b)? Find out in our guide: 401(a) vs. 403(b).
The benefits of a 403(b) plan
Did you know that, after health insurance, work-sponsored retirement plans are the most-requested benefit amongst employees? In fact, adding a 403(b) to your benefits package could be a competitive advantage in the race to hire and retain great talent for your nonprofit. 90% of employees 18 to 34 years old say they would prefer benefits over a raise.
But there are many other benefits of offering a 403(b). Let’s discuss a few here:
With a 403(b), you can enjoy many different benefits. You won’t have to pay taxes on any of your earnings until you make a withdrawal. A Roth 403(b) plan produces tax-deferred earnings, as well, if the withdrawals are qualified distributions that follow relevant rules. Many employers offer matching contributions to 403(b)s, making this account an excellent way for organizations to attract skilled workers. However, matching employee contributions can increase costs for employers.
Easier ERISA requirements
A 403(b) that doesn’t get matching contributions also won’t need to meet the strict requirements of the Employee Retirement Income Security Act (ERISA). Administrative fees could be lower than the ones for plans that get more oversight. Many 403(b) plans will vest your funds sooner than a typical 401(k). Some even allow immediate vesting.
If a 403(b) plan doesn’t have ERISA protection, creditors could access the funds in your account more easily. Non-ERISA 403(b)s are also exempt from nondiscrimination testing. Plans normally get these tests yearly to help keep management or highly paid employees from getting a disproportionate amount of benefits. Without ERISA protection, the plan doesn’t need to follow the same stringent standards to ensure the safety of funds.
Easier catch-up contributions
If you have over 15 years of service with some government agencies or nonprofits, you could be able to make more catch-up contributions than the contributions permitted under a 401(k). You can contribute an extra $3,000 per year, and the lifetime limit for catch-up contributions is $15,000. Unlike most other retirement plans, you won’t need to wait until you turn 50 to take advantage of this benefit. If you leave your employer, you can use your 403(b) plan before retirement in some circumstances.
403(b)s: the basics
Employees of public schools and tax-exempt organizations can participate in a 403(b) plan. Beneficiaries include many school administrators, teachers, government employees, professors, librarians, doctors, nurses, and ministers or priests. Churches often have special plans called 403(b)(9)s.
A 403(b) plan offers tax breaks to help you increase your retirement savings, and it usually includes several options for investments. Like a 401(k), contributions to you 403(b) come directly from your paycheck. You can contribute up to $19,500 per year, and you can add an additional $6,500 if you’re 50 or older. The sum of employee and employer contributions must be less than $57,000 per year or 100% of the employee’s salary for the most recent year.
A Roth 403(b) uses post-tax funds. However, participants still need to reach age 59 ½ to withdraw their money without incurring a penalty. You must also receive Required Minimum Distributions or RMDs after age 70 ½. Most organizations offer either a 401(k) or a 403(b), but some offer both options to their employees. In this situation, you can contribute to both plans or just one. However, your total contribution must be less than the $19,500 limit. Any 401(k) catch-up contributions won’t reduce your contribution limit.
403(b)s serve tax-exempt organizations and employees of public schools instead of private-sector workers, but they’re like 401(k)s in many other ways. After you become vested in your 403(b), you can roll all of your money over into an IRA account when you change jobs. However, if you’re not vested, you can’t keep your employer’s contributions.
Some employers require a rollover when an employee stops working, and others will let you keep your money in your 403(b) as long as a minimum balance stays in the account. Your organization’s human resources representative can let you know about your 403(b)’s rules or help you get in touch with a person who can.
ERISA vs. non-ERISA 403(b) plans
Because both private and public section organizations can offer a 403(b), studying national trends among them isn’t easy. In addition, some plans are subject to the Employee Retirement Income Security Act of 1974 (ERISA) whereas others are not. You can generally assume a 403(b) plan is subject to ERISA unless it meets specified exceptions. One of those exceptions relates to the employer match: for a non-ERISA 403(b) plan is that there must not be any employer contributions (aka an employer match).
The disadvantages of a 403(b) plan
Penalties for early withdrawals
A 403(b) is a tool to help save for retirement, not to cover expenses before then. As such, the IRS imposes a 10% tax penalty on all funds withdrawn from a 403(b) before turning 59 ½. The only way to avoid this penalty is if you are 55 or older under certain circumstances: being fired, laid off, or becoming disabled.
Limited fund choice
In the past 403(b) providers did not give nonprofits the same flexibility in the number of investment options they could choose for their plan. However, most 403(b) plans have at least a few mutual fund choices. In many cases, they’re part of a variable annuity contract. Mutual funds and fixed or variable contracts are the only kinds of investments that 403(b) plans permit. You can’t use this type of plan to invest in stocks, real estate investment trusts, or other securities.
Fortunately, there are now 403(b) providers that provide nonprofits with far more investment choices than traditional providers.
403(b)s vs. IRAs: what’s the difference?
An IRA can let you save for retirement. While employers sponsor 403(b) plans, individuals must open and fund their own IRA. Employers don’t contribute to IRAs, and each type of plan has different contribution limits: You can’t save as much per year in an IRA as you can in a 403(b).
Contribution limit for 2020, 2021
An IRA usually offers more investment options than a 403(b), but you may not get much advice on how to manage your money. The fiduciaries who manage 403(b) plans have a legal duty to offer investment options that match the best interests of the account owners.
What does a larger contribution limit mean?
In short, it could mean a $500,000 difference when you retire. The higher contribution limit of a 403(b) can help your nest egg grow bigger faster. Here’s an example of what it would look like if a person maxed out their retirement savings using a Human Interest 403(b) versus an IRA over a 20-year period (assuming the same 5% rate of return). In this example, by using a 403(b), their nest egg would grow to roughly $719,700 whereas it would get to just $219,900 using an IRA.
*Note: The figure depicts hypothetical savings based on a $6,000 annual contribution for an IRA versus a $19,500 annual contribution for a Human Interest 403(b) over a 20-year period.
Your nonprofit can benefit from a 403(b)
A 403(b) plan could benefit your organization and its employees. Contact Human Interest for more information about a low-cost plan for your nonprofit.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.