The 403(b) plan is often thought of as a 401(k) plan for nonprofits. It's probably not the only option for your not-for-profit, but it can provide certain advantages over 401(k)s. Following is a brief rundown.
A 403(b) plan is a tax-favored qualified retirement plan set up for employees of not-for-profit organizations, including charities, hospitals, schools and government entities. As with other qualified plans, pre-tax contributions grow tax-free until withdrawals are made. Normally, employee contributions are deducted from their regular paychecks. Although participants will owe tax on withdrawals, the expectation is that they'll be in a lower tax bracket in retirement. Participants generally have several investment options, such as stock and fixed-income mutual funds.
Participants can contribute as much as $20,500 to their 403(b) plan in 2022. If they're age 50 or older, they can kick in an extra $6,500 in catch-up contributions, for an upper limit of $27,000. (Proposed legislation could increase catch-up contributions to $10,000 for certain workers near retirement.)
To further sweeten the pot, employees who've worked for your not-for-profit for at least 15 years can contribute an additional $3,000 a year for five years (for a lifetime total of $15,000) so long as they've previously made average contributions of less than $5,000 per year. Finally, not-for-profits can match a percentage of employee contributions to their 403(b)s. The limit for both employer and employee contributions in 2022 is the lesser of $61,000 ($67,500 for employees 50 years or older) or 100% of compensation.
Note: Some nonprofits also offer employees a Roth 403(b) plan. These are funded with after-tax dollars and withdrawals usually are tax-exempt.
As with 401(k) plans, distributions from standard 403(b) plans are taxed at ordinary income rates. (Withdrawals from Roth 403(b) plans in existence for at least five years are tax-free.) Usually, distributions from 403(b) plans prior to age 59½ face a 10% penalty tax, on top of regular income tax. However, there's no penalty for distributions made on death or disability of the participant or in cases of financial hardship.
Other exceptions to the penalty tax include:
The rules relating to contributions and distributions are often the same with both 403(b) and 401(k) plans, but there are some important differences:
Should your nonprofit adopt a 403(b) plan? It depends on your organization's circumstances, including the number of employees. In many cases, the tried-and-true 403(b) plan remains the optimal choice for not-for-profit organizations. But you should consult with your professional tax advisor and a benefit plans specialist before deciding.
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