403(b) vs 401(k): Which Plan a Nonprofit Should Use

Every nonprofit that starts looking at retirement plans is told the same thing within about ten minutes: you are a charity, so you want a 403(b). It is usually right and it is almost never explained, which means a lot of small organisations adopt a plan without understanding the three things that actually separate it from the alternative.

Those three things are eligibility, testing and ERISA. A 403(b) cannot make people wait a year to defer the way a 401(k) can. It escapes the annual test that limits what your leadership can put away when nobody else is contributing. And in one specific configuration it can sit outside ERISA altogether, which removes an annual filing and a set of fiduciary duties that most small charities do not know they have taken on. Two of those are advantages and one is a constraint, and which is which depends on your payroll.

This is a practical walk through all four of the numbers you will hear, 403(b), 401(k), 401(a) and 457(b), aimed at somebody choosing rather than somebody already administering. I build the people and records tooling for organisations without an HR department at FirstHR, which is an onboarding and HR platform rather than a retirement plan provider. This is general information and not tax, legal or investment advice, and the plan document always wins over anything written here.

What a 403(b) Actually Is

A 403(b) is a salary deferral retirement plan available only to a defined list of employers, and to the employee it works almost exactly like a 401(k): money comes out of pay before tax, or after tax if the plan offers a Roth option, and grows sheltered until it is drawn.

The differences from a 401(k) are all on the employer side. Your staff will not notice which one they are in, and the enrolment conversation is identical. Your finance lead, your auditor and whoever handles the annual filings will notice a great deal, and that is where the choice actually gets made. The IRS sets out the plan type and the employers eligible to sponsor it (Internal Revenue Service).

Who Is Allowed to Offer Each Plan

Eligibility to sponsor is the first filter, and it eliminates options faster than any other consideration. Not every employer can offer every plan, and two of the restrictions catch people out regularly.

The two surprises in that list are worth naming. A 501(c)(3) charity can sponsor a 401(k) and has been able to since plan years beginning after 1996, so the assumption that a nonprofit must use a 403(b) is simply wrong. And a state or local government generally cannot start a 401(k) at all, because the ability to do so was closed off in the mid-1980s and only pre-existing arrangements were preserved.

That leaves most small charities with a genuine choice between a 403(b) and a 401(k), and most public employers with a choice between a 403(b), a 401(a) plan and a governmental 457(b). Nobody has all four on the table at once.

How a 403(b) Differs From a 401(k)

Six differences matter in practice, and the first four decide almost every case: who may sponsor it, how eligibility works, what testing applies, and whether ERISA is in play.

The investment row is the one small employers underestimate. A 403(b) can hold annuity contracts and custodial accounts invested in mutual funds and nothing else. That rules out individual securities and brokerage windows, and it has historically pulled 403(b) plans towards insurance products with fee structures that deserve a hard look before you sign. It is not a reason to avoid the plan type. It is a reason to ask what the underlying fund expenses are, in writing, before anybody enrols.

The last row is where the real planning happens for a senior employee, and it points at running two plans rather than picking one. I come back to that below, because the arithmetic is better than most people expect.

The Universal Availability Rule

Universal availability means that if you let one employee make salary deferrals into your 403(b), you must give the same opportunity to all of them, with only a short list of permitted exclusions.

This is the rule that does the work the annual deferral test does in a 401(k), and it cuts the opposite way. A 401(k) lets you restrict who gets in and then tests whether the outcome is lopsided. A 403(b) lets nearly everybody in and does not test the outcome at all. For an organisation whose leadership wants to defer meaningfully while most staff defer nothing, that trade is decisively in the 403(b) column.

The 20-hour exclusion needs care. It is measured by actual hours of service rather than by a job title, so somebody hired as part-time who consistently works 25 hours is not excluded. The long-term part-time rules have narrowed it further: an employee with at least 500 hours of service in each of two consecutive twelve-month periods now has to be allowed to defer, even if they were previously excluded under the 20-hour rule.

What trips employers up is not the list of exclusions. It is the requirement that the opportunity be effective. A plan where nobody was told they could enrol, or where the enrolment form has not been circulated in three years, is not satisfying universal availability regardless of what the plan document says. One clear annual communication, sent to everybody, is the cheapest compliance you will ever buy, and it doubles as the benefits communication most small organisations skip.

Nondiscrimination: What Applies

A 403(b) is not exempt from nondiscrimination rules generally. It is exempt from one specific test, and the exemption depends on who sponsors the plan.

Elective deferrals in a 403(b) are not run through the annual deferral percentage test. That is the whole point of universal availability, and it removes the failure mode that catches small 401(k) sponsors every spring: contributions refunded to owners and senior staff, taxable, because participation among everybody else was too thin for the averages to work.

Employer contributions are treated differently. In a plan sponsored by a 501(c)(3), employer matching and nonelective contributions are subject to the coverage requirement, the general nondiscrimination requirement, the annual compensation cap of 360,000 dollars for 2026, and the matching contribution test. Governmental plans and non-electing church plans are broadly exempt from those requirements, which is a meaningful administrative gap between a public school and a small charity running what looks like the same plan.

Which is why the honest comparison runs through cost. A safe harbor 401(k) buys the same freedom from testing that a 403(b) has by default, and it buys it with a required employer contribution that vests immediately. If you were going to make that contribution regardless, the testing advantage of the 403(b) is worth less than it looks.

Whether ERISA Covers Your Plan

This is the difference nobody mentions and the one with the sharpest edges: a 403(b) can sit outside ERISA in a way that no 401(k) ever can, but only in a narrow configuration that is very easy to break.

A plan sponsored by a public school is a governmental plan and is outside ERISA. A plan sponsored by a church that has not elected coverage is outside ERISA. A plan sponsored by a 501(c)(3) is inside ERISA unless it fits a regulatory safe harbour built around the idea that the employer is doing almost nothing beyond forwarding payroll deductions (29 CFR 2510.3-2).

None of that means you should chase the exemption. An ERISA plan is a perfectly normal thing to run, and the protections it gives participants are real. What matters is knowing which side of the line you are on, because a plan that thinks it is exempt and is not has an unfiled annual return accumulating penalties quietly in the background.

If you are anywhere near this line, get it confirmed in writing by the provider or by counsel. It is a fifteen minute question with a five figure answer.

What a 401(a) Plan Is

A 401(a) plan is an employer-funded qualified plan where the employer sets the contribution formula, the eligibility rules and the vesting schedule, and employees generally have no say in whether they participate.

The confusion here is structural. Section 401(a) of the code is the section that defines a qualified plan, so a 401(k) is technically a 401(a) plan with a cash or deferred arrangement attached to it. When somebody in the nonprofit or public sector says 401(a) plan, though, they mean something specific: a money purchase or profit sharing plan that the employer funds on a fixed formula, used alongside a deferral plan rather than instead of one.

The typical shape at a university or a public agency is a 401(a) plan carrying the employer contribution, a 403(b) carrying voluntary employee deferrals, and sometimes a 457(b) on top for senior staff. Each does one job. The 401(a) plan is the one that guarantees a contribution regardless of what employees choose to do.

For an organisation under about fifty people, the honest answer is that a separate 401(a) plan is rarely worth the administration. Put the employer contribution in the 403(b) and run one plan.

What a 457(b) Plan Is

A 457(b) is a deferred compensation plan with a contribution limit of its own that is not shared with a 403(b) or a 401(k), which makes it the only genuine way for a nonprofit employee to shelter roughly twice the annual deferral amount.

That is the attraction, and it is real. It is also where the two versions of the plan diverge so sharply that treating them as one product is the most expensive mistake in this article.

The second and third rows are the ones to read twice. A tax-exempt 457(b) must remain unfunded, which means the money legally belongs to the organisation and would be available to its creditors if it failed. Rabbi trusts are commonly used and do not change that outcome. The IRS is explicit about the constraint and about the top-group restriction (non-governmental 457(b) plans).

The three-year catch-up is the other feature worth knowing. In the three years before the normal retirement age set by the plan, a participant may contribute up to twice the annual limit, capped at 49,000 dollars for 2026, but only to the extent of deferrals they left unused in earlier years. Somebody who has always contributed the maximum gets nothing from it. It also cannot be combined with the age 50 catch-up in the same year, so a governmental participant uses whichever is larger.

How the Limits Interact

The rule that decides whether a second plan is worth running is short: 401(k) and 403(b) deferrals share one annual limit between them, and a 457(b) has its own.

Those figures come from the annual cost of living adjustments the IRS publishes each autumn (IRS). They change most years, so treat any number written down inside a plan communication as needing an annual refresh rather than as permanent.

Two consequences follow. The first is that an employee at an organisation offering both a 403(b) and a 457(b) can defer 24,500 dollars into each for 2026, which is 49,000 dollars of sheltered pay before any catch-up is added. Nothing else in the small employer toolkit comes close. The second is subtler: the total annual additions limit is applied per plan, and a 403(b) is treated as maintained by the participant rather than by you, so a common-law employee generally does not have to aggregate their 403(b) with your separate 401(a) plan for that limit. That is genuinely useful in a university-style structure and it stops applying if the participant controls the other employer, which is the trap that catches consultants and physicians with side practices.

One more timing point. From 2026 the catch-up contributions of employees whose prior year wages from you exceeded 150,000 dollars have to be made on a Roth basis. It applies to 401(k), 403(b) and governmental 457(b) plans, and it means your plan needs a Roth feature or those employees lose their catch-up entirely. Confirm with your provider that yours does.

Choosing a Plan

Most of this decision is settled by two facts about your organisation: who you are allowed to sponsor for, and whether you intend to put employer money in.

If you also operate in a state with a mandated retirement programme, sponsoring any of these plans normally exempts you from the state mandate, but the exemption usually has to be claimed rather than assumed.

Common Mistakes

Five patterns, and the first two account for most of the real damage I see at small organisations.

Assuming a nonprofit must use a 403(b) is first. It is the default, not the requirement, and a 401(k) is frequently the better product for a charity that wants a broader investment menu and a deeper provider market. Ask for both quotes.

Breaking the ERISA exemption by accident is second. A small employer adds a two percent match to be generous, or switches on automatic enrolment because participation is poor, and does not realise the plan has just become a full ERISA plan with fiduciary duties and an annual return that nobody has filed.

Treating a tax-exempt 457(b) as a normal retirement plan is third. It is limited to a select group, the money stays on your balance sheet, and it cannot be rolled anywhere. Offering it to mid-level staff breaks it for everybody in it.

Letting universal availability lapse is fourth. The rule is not satisfied by a plan document. It is satisfied by an effective annual opportunity to enrol, given to everybody who is not in one of the permitted excluded categories, and it is the most commonly cited 403(b) failure at small employers.

And running three plans at a fifteen person organisation is last. The structure that makes sense at a university is overhead at a charity. One plan explained clearly beats three plans nobody understands, which is the same lesson that applies across your whole employee benefits package.

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