Weighing 403(b)s versus 401(k)s for Nonprofits

In most cases, the 403(b) is the better option.

Cammack Retirement Group was founded in the 1960s specifically to specialize in 403(b) plans for nonprofits and, today, while the practice has expanded to cover 401(k) plans, many of the advisory practice’s clients are still nonprofits.

A common question that comes up is whether clients should offer a 403(b) plan, a 401(k) plan or both, says Mike Webb, a vice president with Cammack.

The question typically comes up because another practice has solicited Cammack’s clients to offer a 401(k) plan, Webb says. Cammack will then sit down with the client to go through the pros and cons of both offerings, he says.

The biggest driver of offering a 403(b) plan is the fact that such plans are not subject to discrimination testing, he says. For nonprofit hospitals with highly paid physicians, nonprofit museums with highly paid directors and nonprofit institutions of higher learning with highly paid professors, a 403(b) plan is the better choice, he says. 401(k) plans, on the other hand, are subject to discrimination testing and even if the sponsor offers a match, that leads to yet another test, the average contribution percentage test, he notes.

Large, more complex nonprofits are a different story, however, Webb says, because they are likely to have a for-profit affiliate. For instance, many hospitals acquire physician groups. Churches commonly have publishing houses, and museums have gift shops. Because employees of a for-profit entity cannot participate in a 403(b) plan, the only retirement savings option for these entities is a 401(k), so in these cases, Cammack will recommend that the nonprofit division have a 403(b) plan, while the for-profit division be served with a 401(k).

However, there is one other consideration to keep in mind when having the 403(b) versus 401(k) debate, and that is the fact that, except for 403(b)(9) church plans, 403(b)s can only invest in fixed and variable annuities and mutual funds. Physicians and professors, in particular, are often keen on investing in individual stocks and bonds, Webb notes. In addition, “401(k) pricing can be very attractive,” he says.

Inevitably, Webb concludes, this is a question that comes up every year, and it is a consideration those who advise nonprofits need to be familiar with.

A blog that Webb has written about this subject can be found here.