Non-profits are fully empowered to offer tax-advantaged retirement plans to their employees, though the options available often lead to confusion. While retirement plans are primarily associated with for-profit businesses, tax-exempt organizations face a unique landscape of choices. Clarifying the specific eligibility rules and comparing the features of available options allows an organization to make a strategic choice that supports both its mission and its workforce.
401(k) Eligibility for Non-Profit Organizations
Non-profit organizations can sponsor a 401(k) plan, a possibility that became widely available following legislative changes in 1996. Today, most tax-exempt entities, including 501(c)(3) organizations, are eligible to establish a 401(k) plan for their staff. The eligibility rules for a 401(k) are broader than those for the traditional non-profit alternative. For example, organizations such as 501(c)(6) trade associations, which cannot offer the standard non-profit plan, can utilize the 401(k) structure. This flexibility makes the 401(k) a common choice for non-profits seeking a plan that is competitive with the private sector for attracting and retaining talent.
Understanding the Standard Non-Profit Retirement Plan: The 403(b)
The 403(b) plan is the traditional defined contribution option for specific tax-exempt organizations. Named for the section of the Internal Revenue Code that governs it, the plan is generally available only to public schools, hospitals, and 501(c)(3) entities. It permits employees to make tax-deferred contributions through payroll deductions. Contributions must be invested in either annuity contracts or custodial accounts that hold mutual funds.
A key distinction for 403(b) plans is their status under the Employee Retirement Income Security Act (ERISA). Governmental employers and church organizations are automatically exempt from ERISA, which reduces their administrative and fiduciary burden. A private 501(c)(3) organization can also achieve non-ERISA status, but only if its involvement is strictly limited to administrative duties, excluding employer contributions or discretion over investment choices. If the organization chooses to make matching contributions or takes on more administrative control, the plan becomes subject to the full suite of ERISA requirements.
Key Differences Between 401(k) and 403(b) Plans
A primary operational difference lies in the rules preventing disproportionate benefits for highly compensated employees. The 401(k) is subject to complex annual non-discrimination tests, specifically the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. These tests can be difficult to pass, often requiring the plan to limit contributions for highly compensated staff if participation among rank-and-file employees is low.
The 403(b) plan avoids the ADP test for elective deferrals by adhering to the Universal Availability Rule. This rule requires that if one employee is permitted to make elective deferrals, all employees must be given the same opportunity, with limited exceptions. This mandate means the opportunity to contribute must be extended almost immediately to all staff, offering less flexibility than a 401(k) plan. While base annual contribution limits are identical, the 403(b) offers a unique catch-up contribution option for long-tenured employees who have completed 15 years of service with the same employer.
In terms of investment options, 401(k) plans generally allow for a much wider array of investments, including individual stocks, bonds, and collective investment trusts. The 403(b) remains more restrictive, typically limiting investments to annuity contracts and mutual funds held in custodial accounts. The administrative burden also varies significantly based on ERISA status. Almost all 401(k) plans are subject to ERISA, mandating rigorous fiduciary standards, annual Form 5500 filings, and a costly independent audit once the plan reaches 100 participants. A non-ERISA 403(b) plan benefits from far fewer disclosure and reporting obligations, making it an attractive choice for smaller organizations.
Other Retirement Savings Options for Non-Profits
Organizations seeking simpler, less administratively demanding retirement structures have access to several other options.
Simplified Employee Pension (SEP) IRA
The SEP IRA is an employer-funded plan that is easy to establish and maintain, with minimal reporting requirements. Non-profits of any size can sponsor a SEP IRA. The employer can contribute a significant amount each year, up to the lesser of a percentage of the employee’s compensation or a maximum dollar limit.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
This option is for smaller non-profits, defined as those with 100 or fewer employees. The SIMPLE IRA simplifies compliance by mandating a specific employer contribution. This contribution is either a dollar-for-dollar match up to three percent of compensation or a fixed two percent non-elective contribution for all eligible employees. The mandatory employer contribution and lower administrative complexity make this plan an accessible entry point for organizations.
Governmental 457(b) Deferred Compensation Plan
Certain government-affiliated non-profits, such as state-level entities or local government instrumentalities, may offer a Governmental 457(b) Deferred Compensation Plan. This plan allows employees to defer income and save for retirement. Its unique rules allow participants to avoid the ten percent early withdrawal penalty that applies to 401(k) and 403(b) plans if they separate from service. The 457(b) can be offered alongside a 403(b) or 401(k) for eligible employees, allowing participants to double their annual tax-advantaged deferrals.
Fiduciary Responsibilities and Plan Implementation
Regardless of the retirement plan structure chosen, the sponsoring organization assumes a fiduciary duty to its employees. This duty requires the organization and its decision-makers to act solely in the participants’ financial interest, with the care and skill of a knowledgeable professional. This obligation governs all aspects of plan management, from initial design to ongoing administration.
Due diligence in selecting a plan provider is a first step, requiring a thorough, documented process of reviewing and benchmarking services and fees. The organization must evaluate prospective providers based on their experience, service quality, and the reasonableness of their costs relative to the services offered. Establishing a formal governance structure, such as a retirement plan committee, helps manage and document all decisions related to the plan.
Ongoing administrative compliance requires attention to detail, including timely filing of the annual Form 5500 (for ERISA plans) and maintaining a written plan document that reflects current regulations. Furthermore, the organization must monitor service providers and the plan’s investment options regularly to ensure that fees remain reasonable and that the investments perform prudently. The commitment to a continuous, documented process of review and oversight is the foundation of fulfilling the organization’s fiduciary obligation.