Nonprofit organizations can offer intrinsic benefits to employees, and they can also provide traditional benefits like retirement plans. Employees will eventually stop working someday, and a workplace retirement plan is one of the most powerful tools for building significant retirement savings. What’s more, those plans may provide tax advantages that staff members can’t find outside of the workplace.
So, which types of retirement plans work best for nonprofit organizations?
Retirement Plans for Nonprofits
Nonprofit organizations typically use 403(b) plans, 401(k) plans, SIMPLE IRA plans, and other retirement plans for employees. Traditionally, 403(b) plans were a default option for nonprofits, but 401(k) plans are a viable option for some organizations, and SIMPLE plans may make sense when employers want a basic plan with minimal costs.
Other plans are available (including DB, nonqualified plans, and more) and the rules for those plans can quickly get complicated. For most private organizations that simply want to help employees save for retirement, a 401(k), 403(b), or SIMPLE plan may be a good start. Governmental bodies and religious organizations can find 403(b) plans more useful—and some private nonprofits may choose 403(b) over 401(k) as well.
We’ll cover some unique features of 403(b)plans at the end of this article.
401(k) Plans vs. 403(b) Plans for Nonprofits
Nonprofit organizations primarily used 403(b) plans in the past, and many still use those plans. But the rules have changed over time, and private nonprofits may choose 401(k) plans for the following reasons:
- Regulations now require many 403(b) plans to function more or less like 401(k) plans (maintaining a written plan document, for example).
- There are more 401(k) providers to choose from, so 401(k) plans have more options and more competition to keep pricing competitive.
- Some tax-exempt organizations, like 501(c)(6) business leagues, are not eligible to use 403(b) plans.
Significant contribution limits: Both 401(k) plans and 403(b) plans allow employees to save substantial amounts:
- Employees can defer up to $19,000 of their pay ($18,500 for 2018)
- Total contributions to an individual’s account, including employee salary deferral, employer matching, and profit-sharing contributions, can be as high as $56,000 ($55,000 for 2018).
- Catch-up contributions allow those over age 50 to contribute an additional $6,000 for 2018 and 2019.
Note: 403(b) plans may offer an additional catch-up contribution, described below.
Roth and pre-tax options: Both 401(k) plans and 403(b) plans allow after-tax Roth contributions, assuming the employer chooses to include that feature. Employees can generally save Roth money in the plan, even if they’re disqualified from making Roth IRA contributions.
Loans and Hardship withdrawals: Both types of plans may allow employees to access their savings in the retirement plan under certain conditions. However, the employer must choose to offer those options (some employers offer one or the other, and some employers don’t allow loans or hardships).
- Loans: If allowed, employees can typically borrow up to $50,000 or 50 percent of their vested account balance (whichever is less).
- Hardship withdrawals: If allowed, employees may be able to take a distribution from the plan, which may be subject to taxes and penalties. Employees generally need to qualify for a hardship withdrawal by showing that they need the funds.
While 403(b) and 401(k) plans are similar, that doesn’t mean they’re equivalent for all tax-exempt organizations. Scroll down for details on what makes 403(b) plans unique.
SIMPLE IRA Plans
Nonprofit organizations often need to minimize costs. Funding may be sparse, and the board may be hesitant to be too cavalier with donor money—paying for retirement plan administration and generous contributions to employee accounts. There’s nothing wrong with that, as nonprofits exist primarily to serve their mission.
A SIMPLE plan may be a less-expensive option. For a basic retirement account that allows employees to save meaningful amounts each year, a SIMPLE is typically sufficient.
No administration costs: Unlike 401(k) plans and many 403(b) plans, SIMPLEs do not require employers to pay annual administration or other costs typical of larger retirement plans.
Meaningful contribution limits: Employees can save up to $13,000 in a SIMPLE IRA during 2019 ($12,500 in 2018). Those over age 50 can make an additional $3,000 catch-up contribution for 2018 and 2019.
Easier to administer: SIMPLEs are somewhat rigid, and that makes them inexpensive and (usually) easy to work with. There’s no discrimination testing, but there are a few potential drawbacks to be aware of:
- No Roth: SIMPLEs only allow for pre-tax contributions. If employees want to make after-tax savings, they may need to do so in a Roth IRA (if allowed).
- No loans: Employees cannot borrow against their assets through the SIMPLE plan. This may make them hesitant to participate or cause tax issues if they take distributions.
- Immediate vesting: Employees can withdraw funds from their SIMPLE account at any time. Once money hits the account (even if it’s employer money), the money is theirs to take when they want it. That may not be ideal if employees lack discipline or if the organization wants to incentivize long-term employment.
- Early-withdrawal penalty: Taking distributions from a retirement account may result in income taxes, additional tax penalties, and other complications. With SIMPLE plans, the early withdrawal penalty is 25% (as opposed to 10% for traditional IRAs).
- No other plan: SIMPLE plans may limit your ability to start other types of retirement plans during the same year.
Employer cost: The “costs” to employers are primarily the required employer contribution and the administrative tasks of running the plan. Employers must choose between:
- 3 percent of pay: Employees receive 3 percent of their earnings each year.
- 2 percent match: Employees receive a 100 percent match on their contributions, up to 2 percent of their pay.
In limited cases, the organization can reduce that contribution.
For most nonprofits, a SIMPLE is one of the least expensive and easiest-to-manage retirement plans. If you decide that you’re outgrowing a SIMPLE, you can always switch to a 401(k) or 403(b) (or another plan) down the road.
Payroll Deduction IRA
Payroll deduction IRAs are even less expensive and less restrictive than SIMPLEs. The organization does not make any contribution to employer accounts, so the cost is simply the administrative time it takes to help employees save money.
With a payroll deduction IRA, employees establish an individual retirement account (IRA), and the employer makes contributions for employees. Your employees could just open an IRA on their own, but many people don’t take action, and making things easier is sometimes all it takes to encourage healthy financial behavior.
Roth and traditional (maybe): Employees can choose to contribute on a pre-tax or after-tax basis. However, employees need to be eligible to use certain tax features (like Roth, or taking a deduction for contributions), and several factors in their financial lives can cause complications. Unlike a 401(k) or 403(b) plan, which allows everybody to contribute regardless of their income or other details, IRAs can be limited. Employees should verify their ability to make contributions with their tax advisor, as well as review IRS rules:
If employees don’t qualify for deductible contributions or Roth contributions, they may still be able to make after-tax contributions. From there, they may choose to convert to Roth or take other actions.
Not automated: Employees need to verify their eligibility to contribute, and they need to complete any required tax reporting on their own. The W-2 will not show a reduced number for contributions to their account—employees are responsible for claiming deductions, among other things.
No employer discrimination testing or annual reporting: Because everybody uses their own IRA (and the “I” refers to “individual”), employers are not responsible for annual reporting on the program, and there’s no discrimination testing.
Immediate vesting: Since all money in a payroll deduction IRA is from the employee’s earnings, the funds are 100% immediately vested. Employees can take withdrawals or transfer funds at any time, but they may face taxes and penalties.
Other Types of Plans
For organizations with significant cash flows or highly compensated employees, defined benefit (DB) and nonqualified deferred-compensation (NQDC) plans may also be a good fit. The rules for those plans are different, and they naturally have pros and cons, but those plans are beyond the scope of this discussion. Staff may also have the opportunity to save retirement money in an HSA, but that’s related to the healthcare plan (if any).
What Makes 403(b) Plans Unique for Nonprofits
Although 401(k) plans have gained popularity for nonprofits, 403(b) plans offer several features that 401(k) plans cannot provide.
Reduced discrimination testing: Administering a 403(b) plan can be easier in some cases, especially if the organization doesn’t plan to make employer contributions (like matching or “profit-sharing” contributions). There’s no requirement to complete a top-heavy test or contribution (if your plan meets the criteria), and other requirements might be lighter. Those features may make it easier for highly-compensated employees to make significant contributions when other rank-and-file employees choose not to participate.
Additional catch-up: If your plan permits, employees might be able to make additional catch-up contributions of up to $3,000 per year. But the organization and any employee taking that route both need to meet several criteria. The employee must have 15 years of service with the same employer, and the organization must be the right type of organization. That option might not be available unless you are a:
- Public school system
- Home health service agency
- Health and welfare service agency
- Convention or association of churches (or associated organization)
Non-ERISA plans: Some 403(b) plans can operate without meeting requirements of ERISA. That includes many governmental and school 403(b) plans. Non-ERISA status reduces the administrative complexity of running the plan and may eliminate the need to file a Form 5500 each year. Private nonprofits can also qualify for non-ERISA status if they don’t have any employer contributions and have “limited involvement” in the retirement plan. In practice, most private nonprofits don’t meet the criteria. Also, while a non-ERISA plan isn’t subject to as many fiduciary obligations, that’s not necessarily a good thing.
Universal availability: 403(b) plans are typically available to all employees of the organization, with immediate entry into the plan. Some 401(k) plans limit enrollment to those who are at least 21 years old and who have worked for at least one year (as defined by plan rules). That said, 401(k) plans are allowed to use less-restrictive criteria. 403(b) plans can exclude some categories of workers, like part-time employees, but you need to mind the details.
Other differences: 403(b) plans have several other features that apply to specific organizations. For example, a minister housing allowance can be attractive for certain religious organizations. Also, post-severance contributions may allow for contributions to a former employee’s account.
This article provides an overview of retirement plans to help you start the discussion within your organization. But it’s critical that you verify all information with a CPA or qualified tax preparer before making decisions. The author of this article is neither of those, and does not provide tax advice. What’s more, the article is written with no knowledge of your individual circumstances or other details that may be important. As a result, do not rely solely on what you find in these materials.