Editor’s Note: This is Part II of a 3-part series. Part I looked at five different comparisons; this installment looks at comparisons 6-10. Part I is here.
Round 6—Elective Deferral Maximum
401(k) Plans. The maximum elective contribution for 2023 is $22,500 plus $7,500 as an age 50 catch-up contribution for a total of $30,000.
403(b) Plans. In addition to the above limits, under a 403(b) there are special rules that include:
- Long term service Deferrals—For employees that work at least 15 years for the same employer, they can (pursuant to a calculation) potentially contribute up to an additional $3,000 each year subject to a maximum under this rule of $15,000 in the aggregate. This brings the above total for the year to $33,000.
- Special Rules for Church Employees—(1) Regardless of compensation, a church employee may receive contributions up to $10,000 per year with a lifetime limit of $40,000; and (2) church employees working outside of the US (typically foreign missionaries), may receive a contribution up to $3,000 without violating 415 if the employee’s compensation does not exceed $17,000.
WINNER—403(b)
Round 7—Investments
401(k) Plans. Notwithstanding a prohibited transaction, a 401(k) can offer any investment that the employer or their tax advisor selects. Some employers may be conservative while others may add very aggressive investments as a choice.
403(b) Plans. With the exception of church plans under 403(b)(9), investments may only be made in annuity contracts or mutual funds under a custodial agreement. Under a 403(b)(9), there are no exclusions for investment types. In fact, churches are not subject to the prohibited transaction rules under section 4975, therefore investments can even include collectibles! Currently pending is a provision that would permit 403(b)s to invest in collective investment trusts (CITs) and other investments in mutual funds that do not meet the 40 act requirements.
WINNER—For now…401(k)
Round 8—Administrative Costs
401(k) Plans. This is not the case for all plans, of course, but typically these plans have higher administrative fees than 403(b) plans. Some third party administrators (TPAs) charge the same price to administer either plan type.
403(b) Plans. For many of the reasons stated above, being exempt from certain administrative processes can cause the cost to administer a 403(b) plan to be lower than a 401(k) plan. In addition, since the final regulations were issued in 2007, certain vendors will pick up these costs in lieu of the employer or the employees having to pay participant fees. This is true especially when there are multiple vendors under the plan.
There have been quite a few articles that indicate that 403(b) plans are more expensive which is not our experience in this marketplace, especially when the TPA is also the record keeper which in many cases immediately cuts the cost in half compared to the 401(k) plan. There are of course some product producers that charge more for the administration of a 403(b) but truly this is where the vendor offering the plan is not familiar with 403(b) plans and will give the employer a gentle nudge towards the 401(k) “because it is cheaper.”
WINNER—403(b)
Round 9—Required Minimum Distributions
401(k) Plans. Both plans will fall under the basic rule that participants must begin to receive their required minimum distribution (RMD) no later than the April 1 following the later of attainment of age 73 or separation from service. However, 403(b)s have 2 small advantages—see below.
403(b) Plans. If the custodian or issuer tracks the pre-1987 balance in the plan, then the age for distributing the pre-1987 balance is age 75. Also, 403(b)s can take advantage of the aggregation rule that applies to IRAs wherein a participant can calculate the required minimum distribution (RMD) separately for each 403(b) they own, but take the distribution from any one or any combination of their 403(b) accounts. This rule provides flexibility to the employee regarding where they would like to take their minimum. Under the qualified plan rules, each plan (including a 401(k)) must take a minimum with no aggregation rule.
WINNER—403(b) Plan
Round 10—Overall Contribution Limits vs. Layering on the Benefits
401(k) Plans. If the employer has adopted a 401(k) in lieu of a 403(b), the plan will generally be designed to accept all types of contributions into a single plan.
For example, the plan may permit elective deferrals and in addition the employer has the option to contribute a profit-sharing contribution and/or matching contribution. In any event, the maximum annual addition per employee cannot exceed $66,000 for 2023.
403(b) Plans. Here we call it “layering on the benefits.” A 403(b) plan is not aggregated with a 401(a) plan under the 415 limitations, so if the employer were to establish a 403(b) and pair it with a 401(m) plan for the matching contributions, each plan would have a separate 415 limitation for each employee, in essence doubling the amount that can be contributed. Many non-profits have established “paired plans” like this to maximize the amount that all employees can receive per year.
Also unlike a 401(k) plan, 403(b) plan documents permit contributions to the 403(b) and other plans to be outlined in employment agreements or contracts. It is common for 457(b) and (f) plans, 401(a) plans, and even a 409A plan if the nonprofit employer is a church. This means that Plan design by using a 403(b) plan permits a much more robust level of contributions.
Also unlike the 401(k), it has become a popular addition to add, “Deemed IRAs” as a part of the 403(b). It seems this new popular provision for 403(b) plans is due to the fact that there are active advisors assisting with the employer plans, social security assistance and now IRAs (traditional and Roth). During the restatement process many advisors and employers, who understood the importance of managing IRAs in addition to the employer’s plan, picked up this provision. This also was educational for the employees, many of whom did not understand the importance of establishing a Roth IRA before retirement, so that the 5-year aging rule would be met sooner rather than later.
WINNER—DEFINITELY BY KNOCK-OUT!—403(b) Plans
As you can see, there are some distinct advantages to taking a long hard look at adopting or remaining with a 403(b) plan rather than jumping ship in favor of a 401(k) plan. Employers must be sure to consult with a trusted advisor or firm that actually specializes in 403(b) plans. Otherwise, you may not receive a truly objective comparison between the plans that have their best interests in mind. As highlighted above and in the chart that follows, there are areas in both types of plans that will vary, and the answer to the question—“which plan is better?”—will depend on several factors including the type of employer, employee turn-over, and the desired contributions types. So put on your gloves, take a few jabs, and see if your plan makes it to your corner of the ring.
Looking Ahead
Parts I and II were based primarily on non-profit employers; however, it is worth mentioning church plans and governmental plans including public schools. Accordingly, Part III will delve into the uniqueness of church and governmental 403(b) plans and why they work.
Susan D. Diehl QPA, CPC, ERPA, TGPC, BCF ™ is President of PenServ Plan Services, Inc.
Opinions expressed are those of the author, and do not necessarily reflect the views of the NTSA or its members.
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