403(b) vs 401(k): Which Plan a Nonprofit Should Use
How a 403(b) differs from a 401(k) on eligibility, testing and ERISA, what 401(a) and 457(b) plans do, and how the contribution limits stack.
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 organizations adopt a plan without understanding the three things that actually separate it from the alternative.
Those three things are eligibility, testing and ERISA (the Employee Retirement Income Security Act). 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.
A 403(b) can also sit outside ERISA altogether in one specific configuration, which removes an annual filing and a set of fiduciary duties that most small charities do not know they have taken on. Of the three, two 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 organizations 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 enrollment 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).
Is a 403(b) Pre-Tax, and What Still Gets Taxed
Ordinary 403(b) deferrals are pre-tax. The money comes out of pay before federal income tax is worked out, so somebody deferring 500 dollars a month lowers their taxable pay by that amount and pays income tax only when the money is drawn. A plan may also offer a designated Roth account, where the deferral is taxed now and qualified withdrawals come out tax free.
What pre-tax does not cover is the part payroll has to get right. Social Security and Medicare tax still apply to those contributions, including deferrals made under a salary reduction agreement, per IRS Publication 571.
On the W-2, income tax wages fall, but Social Security and Medicare wages do not. Set the deduction up that way before the first deposit rather than correcting it a quarter later.
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.
A state or local government, by contrast, 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 (26 U.S.C. 401(k)(4)).
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). In practice, only a 501(c)(3) that is not a church or qualified church-controlled organization has all four on the table, and even then the tax-exempt 457(b) suits very few people.
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.
| Feature | 403(b) | 401(k) | 401(a) | 457(b) |
|---|---|---|---|---|
| Who may sponsor | Public schools, 501(c)(3), some churches | Almost any employer, but generally not a new government plan | Any employer, in practice governments and nonprofits | Governments and tax-exempt organizations other than churches and church-controlled organizations |
| Employee salary deferrals | Yes, core feature | Yes, core feature | Not typically, employer funded | Yes, core feature |
| Eligibility rule for deferrals | Universal availability, very few exclusions | Service and age conditions permitted | Employer sets the rules | Governmental open to all, tax-exempt top group only |
| Annual deferral percentage test | Does not apply | Applies unless a safe harbor design is used | Not applicable | Does not apply |
| Investment vehicles | Annuity contracts and mutual fund custodial accounts | Broad, set by the plan menu | Broad, set by the trustee | Set by the plan, narrower for tax-exempt sponsors |
| Can it sit outside ERISA | Yes, if deferral only and the employer stays hands off | Only as a church plan, a government plan or a plan covering owners only | Governmental plans are exempt | Governmental exempt, tax-exempt is a top hat plan |
| Shares the deferral limit with a 401(k) | Yes | Yes | Not applicable | No, separate limit |
| Extra catch-up available | 15 years of service catch-up in some organizations | None beyond age based | Not applicable | Three-year pre-retirement catch-up |
The investment row is the one small employers underestimate. Outside church plans, a 403(b) holds annuity contracts and custodial accounts invested in mutual funds. That rules out individual securities, and it has historically pulled 403(b) plans toward insurance products with fee structures that deserve a hard look before you sign.
The right response is not to avoid the plan type. It is to ask what the underlying fund expenses are, in writing, before anybody enrolls, and to ask the same question of the wrapper, meaning the annuity contract that holds those funds. A quote that answers one and not the other is not a quote.
The last two rows are where the real planning happens for a senior employee, and they point 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 (IRS issue snapshot). Generic labels such as part-time, temporary or seasonal are not among them.
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 organization 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. Once anyone crosses 1,000 hours in a year, the exclusion is gone for good and cannot be reapplied when their hours drop again.
The long-term part-time rules narrow it further, but only in plans covered by ERISA. Under ERISA section 202(c), an employee with at least 500 hours of service in each of two consecutive twelve-month periods must be allowed to defer. A 403(b) outside ERISA, such as a public school plan, is not reached by it.
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 enroll, or where the enrollment 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. It doubles as the benefits communication most small organizations skip, and the file of who received it is what you would show an examiner.
Nondiscrimination: What Applies
A 403(b) is not exempt from nondiscrimination rules generally. Whoever sponsors it, a 403(b) is exempt from one specific test, and how much of the rest applies depends on the sponsor.
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 under section 403(b)(12) of the tax code. 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 are exempt from all of those requirements except the compensation cap, and churches and qualified church-controlled organizations are exempt from every one. That is a meaningful administrative gap between a public school and a small charity running what looks like the same plan, and it is worth knowing which side of it you are on before you design a match.
The honest comparison therefore 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 in the traditional design. 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) at a charity can sit outside ERISA through a regulatory safe harbor that no 401(k) has, 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 harbor 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.
In practice, when somebody in the nonprofit or public sector says 401(a) plan, 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 a small organization, 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 IRS sets the two out row by row.
| Feature | Governmental 457(b) | Tax-exempt 457(b) |
|---|---|---|
| Who may participate | Any employee the plan covers | Only a select group of management or highly compensated employees |
| Where the assets sit | In trust, for the exclusive benefit of participants | Property of the employer, reachable by its general creditors |
| What happens in an insolvency | Participant balances are protected | Participants are unsecured creditors and can lose everything |
| Age 50 catch-up | Permitted | Not permitted |
| Three-year pre-retirement catch-up | Permitted | Permitted |
| Rollovers out | To an IRA or another employer plan | Only a transfer to another tax-exempt 457(b) |
| Early distribution penalty | None on 457(b) amounts | None, but distributions are taxed when made available |
| Practical role | A second core retirement plan | An executive retention arrangement |
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 organization and would be available to its creditors if it failed.
Rabbi trusts, which set money aside for the participant but leave it open to the creditors of the employer, 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 the three-year catch-up. It also cannot be combined with the age 50 catch-up in the same year, so a governmental participant uses whichever is larger.
Dwight SchruteSales3 people
Darryl PhilbinWarehouse1 person
Kelly KapoorCustomer Service1 personHow 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.
| Limit | Amount for 2026 | How it applies |
|---|---|---|
| Elective deferral limit | $24,500 | One ceiling across all 401(k) and 403(b) plans a person is in, whoever sponsors them |
| 457(b) deferral limit | $24,500 | Separate, not combined with the above, so both can be used in full |
| Age 50 catch-up | $8,000 | Available in 401(k), 403(b) and governmental 457(b), not in a tax-exempt 457(b) |
| Catch-up at ages 60 to 63 | $11,250 | Replaces the age 50 amount in those four years where the plan offers it |
| 15 years of service catch-up | $3,000 a year | 403(b) only, at qualifying organizations, lifetime cap of $15,000 per employer |
| Three-year 457(b) catch-up | Up to $49,000 | Limited to previously unused deferrals, cannot be combined with the age 50 catch-up |
| Total annual additions limit | $72,000 | Employee plus employer money for one person, with one employer’s plans generally counted together |
| Annual compensation cap | $360,000 | The most pay that can be counted in an employer contribution formula |
Apart from the fixed 15 years of service amounts, 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 organization 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 consequence is subtler. The total annual additions limit normally counts all the plans of one employer together, but a 403(b) contract is treated as maintained by the participant rather than by you.
As a result, a common-law employee (a regular employee on your payroll) generally does not aggregate their 403(b) with your separate 401(a) plan for that limit. The exception is a participant who controls another 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, per IRS Notice 2025-67. 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 organization: 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 program, 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 organizations.
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 enrollment because participation is poor, and does not realize 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 enroll, given to everybody who is not in one of the permitted excluded categories, and failing to give it is one of the ten mistakes named in the IRS 403(b) Fix-It Guide.
And running three plans at a small organization 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.
Nick Anisimov, FirstHR founder
Frequently Asked Questions
What is the difference between a 403(b) and a 401(k)?
They do the same job for the employee and differ mainly in who may sponsor them and how they are policed. A 403(b) may only be offered by a public educational institution, a 501(c)(3) charity or certain church organizations, while a 401(k) is open to almost any employer. A 403(b) escapes the annual deferral percentage test that constrains a 401(k), and instead has to satisfy a rule called universal availability that requires the deferral opportunity to be extended to nearly everybody. Outside church plans, a 403(b) can only hold annuity contracts and custodial accounts invested in mutual funds, where a 401(k) menu can be wider. A deferral-only 403(b) with no employer money can also sit outside ERISA through a regulatory safe harbor that has no 401(k) equivalent.
Can a nonprofit offer a 401(k) instead of a 403(b)?
Yes. A 501(c)(3) organization has been able to sponsor a 401(k) since plan years beginning after 1996, and plenty of them do. The trade is straightforward. A 401(k) gives you a wider investment menu, a deeper provider market, familiar paperwork and the ability to use service conditions on eligibility. In exchange you take on the annual deferral test, which at a small charity with a few well-paid leaders and a larger group of lower-paid staff is the test most likely to fail. A safe harbor design fixes that at a price. Which way you go depends on whether your leadership actually wants to defer near the annual maximum.
What is the universal availability rule?
Universal availability is the eligibility rule that replaces the deferral testing a 401(k) has to pass. If a 403(b) plan lets any employee make salary deferrals, it must offer the same opportunity to all employees, subject to a short list of permitted exclusions: anyone who would elect 200 dollars a year or less, employees eligible under another deferral plan of yours (a 401(k), a governmental 457(b), or another 403(b)), nonresident aliens with no US source earnings from you, employees who normally work fewer than 20 hours a week, and certain students working for a school they attend. The offer has to be genuine and repeated, which in practice means an effective notice at least once a year rather than a line buried in a handbook.
What is a 401(a) plan?
A 401(a) plan is an employer-funded retirement plan in which you decide how much goes in. Section 401(a) of the tax code defines what counts as a qualified retirement plan, which makes a 401(k) technically a 401(a) plan with a salary deferral feature added. When public employers and universities use the term, though, they usually mean a money purchase or profit sharing plan. The employer picks the formula, who qualifies and how quickly the money vests, and employees typically cannot opt out. Government-run versions often add a required employee contribution on top of the employer’s. Choose it when you want to fund retirement on a formula you control instead of depending on what employees decide to defer.
What is the difference between a governmental and a tax-exempt 457(b)?
The name is the same and almost nothing else is. A governmental 457(b) holds assets in trust for the exclusive benefit of participants, may be offered to all employees, allows the age 50 catch-up, and permits rollovers to an IRA or another employer plan. A tax-exempt 457(b) must be limited to a select group of management or highly compensated employees, must remain unfunded so that the assets stay the property of the employer and reachable by its general creditors, does not allow the age 50 catch-up, and cannot be rolled over at all, only transferred to another tax-exempt 457(b). For a charity it is an executive arrangement carrying real risk, not a staff benefit.
Can an employee contribute to both a 403(b) and a 457(b)?
Yes, and this is the most valuable feature of running both plans. Deferrals into a 401(k) and a 403(b) count against one shared elective deferral limit, so a person in two of those plans has a single ceiling across them. A 457(b) has its own limit that stands apart from the others. When an employer sponsors both a 403(b) and a 457(b), an employee can put the full annual amount into each and shelter roughly twice as much pay. For 2026 that means 24,500 dollars into the 403(b) plus another 24,500 dollars into the 457(b), with any catch-up contributions coming on top.
Is a 403(b) plan subject to ERISA?
Not always, which is the practical difference that most affects a small charity. A 403(b) sponsored by a public school or by a church that has not elected coverage sits outside ERISA. A 403(b) sponsored by a 501(c)(3) is covered by ERISA unless it fits a narrow regulatory safe harbor: contributions must be salary deferrals only, participation must be genuinely voluntary, and the employer must keep its involvement to a short list of ministerial tasks. Adding an employer contribution ends the exemption immediately. So does automatic enrollment, and so does choosing investments or exercising discretion over hardship requests. Once ERISA applies, so do the fiduciary duties, the plan disclosure obligations and the annual return.
Does a 403(b) have nondiscrimination testing?
Not on employee deferrals, but employer contributions can be tested. A 403(b) skips the annual deferral percentage test that a 401(k) must pass, because universal availability takes over that job. That is why the plan can suit an organization where leaders want to defer heavily and general participation is low. Money the employer puts in is treated differently. A 501(c)(3) must run its match and nonelective contributions through the coverage rules, the general nondiscrimination requirement, the annual compensation cap and the matching contribution test. A governmental plan avoids every one of those apart from the pay cap, and a church or qualified church-controlled organization avoids all of them. Testing is therefore reduced rather than removed, and the amount of relief depends on who sponsors the plan.
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