Nonprofit Retirement Plans: An Overview of 403(b) Options
A 403(b) retirement plan is often described as a “401(k) for nonprofits.” The two defined contribution plans are certainly similar, but there are important differences between them.
The 403(b) actually predates the 401(k) by several decades. The 403(b) was introduced in 1958 as a supplemental pension for teachers. Back then, annuities were the only permissible investment for these plans. It wasn’t until 1974 that mutual funds could be purchased in 403(b) accounts.
Today about $1 trillion in assets is invested in 403(b) retirement accounts. Plan sponsors include government entities, churches and private non-profits. If you’re curious who some of the biggest names in the space are, check out our list of top 403(b) providers.
Compliance: What is the difference between an ERISA and a non-ERISA 403(b) plan?
Unlike 401(k) plans, not every 403(b) plan must comply with ERISA regulations. In fact, non-ERISA plan assets accounted for 57% of all 403(b) assets in 2013, according to a study by Brightscope and ICI.
Whether a plan is an ERISA or non-ERISA plan depends on the type of organization and the nature of the plan. Governmental employers and schools are not required to offer an ERISA plan. Even a private non-profit can offer a non-ERISA plan if it meets certain criteria including no employer contributions and “limited involvement” with the plan by the employer.
A non-ERISA plan can have significantly reduced administrative requirements, including not having to file an IRS form 5500 and avoiding the annual audit. This is even true for non-ERISA plans with more than 100 participants. Non-ERISA plans also avoid having to comply with key ERISA fiduciary standards, and are not subject to nondiscrimination testing. However, even 403(b) plans that are ERISA plans administer only the ACP test (learn more about compliance testing here). They are not required to undergo the ADP and top-heavy tests as do 401(k)s.
Employee Satisfaction: How do 403(b) plan participation rates compare?
According to a survey from 2015 by the Plan Sponsor Council of America (PSCA), 79.1% of employees participated in their employer’s 403(b) plan, a figure comparable to the participation rate in 401(k) plans. Similarly, 403(b) participants deferred 6.2% of their salary toward retirement in 2015. This figure is not far off the 6.8% employee deferral rate for 401(k) plans. The 401(k) deferral rate is based on a separate 2015 PSCA survey.
The vast majority of non-profit employers with 403(b) plans provided an employer contribution. In fact, just 6.1% of such employers offered no contribution of any kind. The average employer contribution was 4.7% of salary. Employer contributions were even higher for small plans, with a 5.2% average contribution in plans with fewer than 50 participants.
Where 403(b) plans may be falling short is the practice of low salary deferrals associated with auto-enrollment. Of those 403(b) plan sponsors with auto enroll, 75% of them deferred 3% of salary or less. Even if this rate is bumped up automatically each year, it can take years for an inattentive employee to save a meaningful portion of income.
Investment Options: What kind of investments are offered in a 403(b) plan?
When it comes to investments, 403(b) plans are increasingly likely to include target date funds in their line-ups, much like 401(k) plans. More than 70% of 403(b) plans include target date funds, but this percentage shrinks to just over 50% for plans with fewer than 50 participants.
One area where 403(b) plan sponsors seem to have a different view from 401(k) sponsors is their willingness to use their recordkeeper’s proprietary investment products. Defined contribution plans generally are showing an interest in having their investments separate from the recordkeeper’s. However, lawsuits against 403(b) plans run by some universities that allege sponsors rely too heavily on their recordkeeper’s products may have sponsors rethinking this approach. Lawsuits have also questioned the fees paid for 403(b) investment and administrative services. Some plans have also been criticized for offering too many investment choices. Learn more about excessive fee lawsuits here.
The PSCA survey data, which reflects the 2015 plan year, does indicate that more 403(b) sponsors are focusing on fees. The percentage of employers re-evaluating how plan expenses are allocated grew from 16.8% in 2014 to 26.0% in 2015.
401(k) vs 403(b)
The differences between a 401(k) and a 403(b) can be hard to hard to understand. The two retirement plan types have differences in who must be made eligible to participate, some compliance differences. The two plans do have the same annual contribution limits. Learn more about the nuances in our article about the differences between a 401(k) and 403(b) plan.
Which retirement plan is best for your nonprofit?
If you have a non-ERISA 403(b) and are looking to make employer contributions, you may want to consider who will handle the increased administrative load of an ERISA plan. Or if you are wanting to customize employee eligibility, then a 401(k) plan might be the right option for your 501(c)3. If you’d like to speak with an expert, give us a ring to discuss all of your non-profit’s retirement plan options. You can also check out our 403(b) provider evaluation worksheet to help as your compare retirement plan options.
Note: The information contained in this post is not intended to be or relied on as legal advice. You should consult an ERISA attorney or another professional plan consultant before making any decisions or changes.