Why Do So Many Non-profits Have the Wrong Type of Retirement Plan?
There are an estimated two million non-profit organizations in the U.S. This includes public charities, private foundations, and other types of organizations, such as schools and religious institutions. These entities operate under different tax laws and structures than for-profit companies do.
Because non-profit employees tend to receive lower salaries than their for-profit counterparts, non-profit organizations often try to provide enhanced employee benefit packages. The 403(b) plan was created in 1958 as one way to enable employees of non-profits to more effectively save.
Despite the fact that it has been around for almost 70 years, the 403(b) plan goes largely unnoticed by many financial professionals, who are often unaware of the many advantages for non-profit organizations. Payroll companies, for example, and bundled retirement plan providers often stick to and recommend what they’re most comfortable with, which is the ubiquitous 401(k).
This is why many non-profits end up providing a 401(k) plan to their employees. But just because a plan is “convenient” or “familiar” for the retirement plan provider doesn’t mean it’s the right fit for the organizations who use them or the individuals they employ.
What Gets Missed When a Non-profit Is Placed into a 401(k)
For retirement plan providers managing thousands of client plans, offering a single type of plan, such as a 401(k), is efficient for the provider. However, that one-size-fits-all approach causes clients to miss out on the flexibility and advantages a 403(b) plan is designed to provide.
Non-profits have unique considerations, such as budget limits, workforce turnover, leadership compensation, and programmatic priorities. 403(b) plans are specifically designed for non-profits and offer significant advantages and options not in a 401k) plan.
Even if a 401(k) works operationally, it can leave non-profits without the full range of advantages specifically designed for them, with real financial consequences for both employers and employees. Some of the key benefits often overlooked include:
1. Fewer Tests Required
401(k) plans are subject to nondiscrimination tests, such as the Actual Deferral Percentage (ADP) test. When a plan fails any of these tests, employers need to take corrective actions, sometimes including refunding their employees’ retirement plan contributions. This is often a time-consuming, frustrating process, especially for employees who were planning to avail themselves of the tax advantages inherent in making plan contributions.
Because 403(b) plans are regulated differently than 401(k) plans, they don’t require ADP tests. This allows non-profit employees to contribute up to the annual limit without triggering corrective actions.
2. Not Subject to Top-Heavy Rules
When an organization has a 401(k) and their officers hold more than 60% of the plan’s assets, the plan becomes what’s called “top heavy”. This designation may require an employer to make contributions for additional employees in order to no longer test as top heavy.
On the other hand, 403(b) plans are not subject to top-heavy rules, reducing potential compliance surprises for smaller nonprofits.
3. Enhanced Catch-Up Opportunities
Since many non-profit leaders earn less than they could in the private sector, saving for retirement can be more challenging. In recognition of that, certain 403(b) plans allow for special catch-up contributions that are unavailable in 401(k)s.
4. Penalties Often Do Not Apply
For a variety of reasons, late payroll deposits are a common occurrence for many organizations, both for- and non-profit. In a 401(k), they usually trigger excise taxes and IRS filings.
Though non-profits that sponsor 403(b) plans do not pay excise taxes, some providers still apply the same correction process, either out of habit or lack of knowledge, therefore charging their clients needless fees that do not apply to them.
Starting With the Right Question
What this all boils down to is that choosing a retirement plan should not start with what is easiest to administer - it should start by asking, “Who is the employer?”.
For non-profits, this means considering tax-exempt status, compensation realities, and the needs of mission-driven staff. When that conversation happens first, 403(b) plans often emerge as a better fit.
If your non-profit ended up with a 401(k), it may be time to reexamine. 403(b)s exist for a reason: they offer flexibility and advantages designed specifically for non-profit organizations.
