Choosing between a Sec. 401(k) or 403(b) plan.

• Author: Packard, Pamela
• Position: Exempt organizations

Since 1997, Sec. 501(c)(3) organizations (e.g., charitable, religious and educational groups) have been able to adopt and sponsor Sec. 401(k) plans. In addition, Sec. 501(c)(3) organizations are the only tax-exempt entities that can provide Sec. 403(b) plans to their employees.

At first glance, Secs. 401(k) and 403(b) plans seem comparable; both plans are cash-or-deferred arrangements, under which an employee can elect to have pretax payments made to the plan rather than receive the amounts as currently taxable compensation. Also, each plan limits employees' pretax elections to $11,000 in 2002 (Sec. 402(g)), and overall 2002 annual additions to the lesser of $40,000 or 100% of eligible compensation (Sec. 415(c)). Aside from these similarities, however, the two arrangements have significant differences that employers should consider when designing a Sec. 501(c)(3) organization's deferred compensation package.

A Sec. 401(k) plan is a qualified plan subject to ERISA. As such, it must comply with the many written plan document, fiduciary, administrative, reporting and disclosure requirements imposed on qualified plans. Sec. 403(b) plans, however, are not qualified within the meaning of Sec. 401(a) and can avoid ERISA coverage; see Department of Labor Regs. Section 29 CFR 2510.3-2(f).

A non-ERISA Sec. 403(b) plan must meet two general requirements. First, it must limit contributions to voluntary employee salary reductions; employers cannot fund benefits. Second, the employer's involvement in the plan is extremely restricted. Its role is to provide general information about the plan and withhold employee salary reductions and forward them to the plan. Although the salary reductions have a limit, each employee--not employer--is responsible for ensuring that annual contributions do not exceed the allowable amounts.

Sec. 501(c)(3) organizations have four choices for elective deferral arrangements.

1. Stand-alone non-ERISA Sec. 403(b) plan: If an employer is unable to fund a retirement benefit for its employees, it could provide a plan that accepts pretax, employee salary-reduction contributions. Such arrangements have many advantages:

   * An employer avoids virtually all administrative responsibilities and costs.

   * Sec. 403(b) plans are exempt from the actual-deferral-percentage test imposed on Sec. 401(k) plans, so the participation of nonhighly compensated employees (NHCEs) does not limit the contributions of highly compensated employees (HCEs).

   *...