401(k) vs. 403(b): What Private and Nonprofit Employers Should Know

Why the choice matters

For most for-profit businesses, the decision is simple: a 401(k) is the standard option. For nonprofit organizations, the question is more interesting, because many 501(c)(3) employers can choose either plan. The right answer depends on the organization’s goals, budget, workforce, and appetite for administrative work.

Who can sponsor each plan

The IRS describes the basic eligibility rules in its overviews of the 401(k) plan and the 403(b) plan. In short:

• 401(k): available to corporations, partnerships, sole proprietors, and most tax-exempt organizations. State and local governments generally cannot set up a new 401(k).
• 403(b): available only to public schools and colleges, organizations that are tax-exempt under section 501(c)(3), and certain ministers.

A private company cannot offer a 403(b). A 501(c)(3) nonprofit can usually offer either one, and some offer both.

Side-by-side comparison

Feature	401(k)	403(b)
Eligible sponsors	Most private employers, including many nonprofits	Public schools, 501(c)(3) organizations, certain ministers
Employee deferral limit	Annual limit set by the IRS	Same annual limit, shared with any 401(k) the employee also uses
Allowed investments	Broad range, such as mutual funds, collective investment trusts, and other options the plan permits	Generally limited to annuity contracts and mutual funds held in custodial accounts
Testing of employee deferrals	Generally subject to ADP nondiscrimination testing unless a safe harbor design is used	Not subject to the ADP test, but must follow the universal availability rule
ERISA coverage	Generally covered	Public school and church plans are generally exempt; nonprofit plans are usually covered unless employer involvement is very limited
Extra catch-up option	Standard age-based catch-up	Age-based catch-up, plus a special catch-up for some long-service employees if the plan allows it

Differences that matter most in practice

Investment options

Because 403(b) plans are generally limited to annuities and mutual funds, they cannot use some lower-cost structures that are common in 401(k) plans, such as collective investment trusts. For larger plans, that can affect fees. Either way, the plan’s fiduciaries are responsible for choosing reasonable options and reviewing them over time, ideally under a written investment policy statement.

Testing and design flexibility

A 401(k) generally has to pass annual nondiscrimination tests that compare how much highly compensated employees save with how much everyone else saves. Plans that fail may need to return contributions to some employees. Safe harbor designs avoid this test in exchange for required employer contributions.

A 403(b) is not subject to that test for employee deferrals. Instead, the universal availability rule generally requires that if any employee may defer salary, nearly all employees must have the same opportunity. Employer matching contributions in either plan still face their own testing.

ERISA and administrative work

When ERISA applies, the plan must follow its fiduciary standards and reporting rules, including annual Form 5500 filings for most plans. Some 403(b) plans at nonprofits are structured to stay outside ERISA by keeping employer involvement very limited, such as no employer contributions. That can reduce administrative work, but it also limits what the employer can do with plan design and oversight. Organizations considering this approach should get qualified legal advice, since the conditions are specific.

How a nonprofit might decide

A 501(c)(3) organization weighing its options might ask:

1. Does it want to make employer contributions, such as a match?
2. Does it need investment options that a 403(b) cannot hold?
3. Would nondiscrimination testing be a concern for its workforce?
4. How much administrative and fiduciary work is it prepared to manage?
5. Does it have long-tenured staff who might benefit from the special 403(b) catch-up?
6. Is an existing plan already in place, and what would a change involve for employees?

There is no universal answer. A plan that works well for a large hospital system may not fit a small community organization.

Fiduciary oversight applies to both

When either plan is covered by ERISA, the people who run it are fiduciaries with duties of loyalty and prudence. The basics are covered in what it means to work with an ERISA fiduciary. Many sponsors also benefit from a periodic outside review of how the plan is governed.

APS Investment Management, the institutional fiduciary arm of APS Pension & Financial Services in Melville, New York, provides ERISA plan governance and independent advisory services to 401(k), 403(b), and defined benefit plans, and conducts independent fiduciary assessments of 401(k) and 403(b) plans for private and nonprofit sponsors. Steven J. Musmanno, MBA, AIFA, serves as the firm’s Chief Investment Officer. More is on the ERISA fiduciary services page.

Frequently asked questions

Can a nonprofit offer a 401(k) instead of a 403(b)?

Generally yes. Most tax-exempt organizations can sponsor a 401(k). Governmental employers are the main exception, since they generally cannot set up a new 401(k).

Can an employee contribute to both a 401(k) and a 403(b)?

Yes, if they have access to both, such as through two jobs. Their own salary deferrals across both plans count toward a single annual IRS limit.

Is a 403(b) cheaper to run than a 401(k)?

Not necessarily. A non-ERISA 403(b) may involve less administration, but investment costs depend on the options chosen, and some lower-cost vehicles are only available to 401(k) plans.

Do 403(b) plans have to file Form 5500?

403(b) plans that are covered by ERISA generally do. Plans that are exempt from ERISA, such as most public school plans, generally do not.