401(k) or 403(b): which is right for you?
- October 1, 2008
By Anna Hunter
New regulations for 403(b) retirement plans have worried some nonprofit agencies. The government’s new regulations and a requirement that organizations submit a written plan document by Jan. 1, 2009, have caused many nonprofit agencies to consider switching to a 401(k). While a 401(k) may look appealing, nonprofits should understand the consequences before making the decision to switch.
Following are some basic questions to consider:
Is the current 403(b) plan exempt from Title I of ERISA?
If your plan is already exempt from requirements under the Employee Retirement Income Security Act (ERISA), you probably don’t want to switch to a 401(k). The ERISA sets minimum standards for private industry retirement plans and are always applicable to a 401(k). A part of ERISA, Title 1, applies to a 403(b) plan unless it qualifies for an exemption. For example, government and church plans are generally exempt. For other nonprofit entities to be exempt from ERISA Title I, the 403(b) plan must comply with all of these requirements:
• Include only voluntary employee salary deferral elections.
• Offer no employer match.
• Only the employee has enforceable rights.
• The employer receives no compensation and has little plan involvement.
If the plan is subject to ERISA, additional requirements apply to the plan. These requirements are similar to those found in a 401(k) plan.
• Nondiscrimination and coverage testing applies. If there are any “highly compensated employees” (above $100,000), the plan could fail testing and ultimately subject the employer to liability.
• Fiduciary bonding of the employer is required, so insurance must be obtained.
• Full annual reporting is required in 2009, and a plan with 100 or more eligible participants must pay for an independent audit. This increases the expense of operating the plan and adds the burden of having the plan audited each year.
• The Joint Survivor & Annuity rules apply. Spousal consent will be required for distributions.
Are there any highly compensated employees or key employees?
A highly compensated employee (HCE) is an employee who earned more than $100,000 in 2007 or owns more than 5 percent of the company. Key employees are often the same as the HCEs, although to be considered key, an employee: earns more than $150,000 and is an officer, earns more than $150,000 and owns more than 1 percent of the company, or simply owns more than 5 percent of the company. A 401(k) plan cannot operate in favor of HCEs or key employees, and must undergo multiple tests every year to prove enough employees are receiving a meaningful benefit. A 403(b) plan does not have as much testing, so determine if there is going to be a problem before making the decision to change to a 401(k).
Which employees are excluded from participation?
If your 403(b) plan was set up to exclude a group of employees that cannot be automatically excluded under a 401(k) plan, be prepared to pass some additional nondiscrimination testing if you decide to set up a 401(k). By plan design, these employees can be excluded and not adversely affect non-discrimination and coverage testing:
• Employees who actually work less than 1,000 hours of service during a 12- month period.
• Union employees.
• Nonresident aliens.
• Highly compensated employees.
• Employees scheduled less than 20 hours per week and expected to work under 1,000 hours during a 12-month period.
• Nonresident aliens.
• Student employees.
• Employees already eligible in other 401(k), 457(b) or 403(b).
• Employees who make a one-time irrevocable election.
Before making the decision to change from a 403(b) plan to a 401(k) plan, it is important to analyze the consequences of doing so. Many nonprofit agencies are unaware of the differences and may be unpleasantly surprised at the end of an initial 401(k) plan year if proper planning is not undertaken. This column has provided an overview of some common nonprofit organization retirement plan considerations, and may not include every aspect that should be considered. Every situation is different, so before you make a change to your retirement plan, please contact your benefit administrator to discuss which plan is best for you.