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403(b) vs. 401(k) Plans for Non-Financial People

You’ve been taxed with the responsibility of setting up a retirement plan for your tax exempt organization and now you’re trying to decide between a 403(b) or a 401(k) plan. You’ve Googled, you’ve read, you’ve cringed at the technical language presented to you, desperately trying to understand the differences. Been there, done that.

I’m still convinced that the people who write the IRS regulations sit and laugh at us as they draft these rules. It gives me great pleasure to make this decision simple for you. I believe that these two big differences are truly all you need to know when deciding between a 403(b) or 401(k) plan – their eligibility and testing requirements.

Eligibility - So, when can my employees participate?

With a 401(k) plan, you can let employees make elective deferrals immediately or after meeting age and service conditions first. As a brief summary, the maximum age and service conditions permitted by law are age 21 and 1 year of service in which the employee works 1,000 or more hours. You can also make employees wait until an “entry date” to enroll in your plan after meeting the age and service requirements. Want to limit employee eligibility further? You can exclude certain employee classes from your plan as long as annual coverage testing can pass. 

Elective deferrals in 403(b) plans are a different story. They are subject to a Universal Availability Rule which requires an employer to make all employees plan-eligible upon their date of hire – no age and/or service conditions are allowed. Because of this rule, you might want to avoid a 403(b) plan if your company has a lot of turnover. Terminated employees are allowed to leave their account in your plan if it exceeds $5,000. These accounts can increase plan administration expenses and make the distribution of mandatory participant notices more difficult. 

Both 401(k) and 403(b) plans can impose age and service conditions on employer match and non-elective (a.k.a profit sharing) contributions. 


High 401(k) Fees

Testing – Can my high earners maximize their salary deferrals?

Generally, salary deferrals made to a 401(k) plan are subject to Average Deferral Percentage (ADP) testing annually. Failing this test can limit the salary deferrals of Highly Compensated Employees (HCEs) to an amount that’s far lower than the legal limit ($22,500 for 2023). The ADP test fails when the average deferral rate of plan HCEs for the year exceeds the greater of:

  • 125% of the non-HCE average, or
  • the lesser of:
    • 200% of the non-HCE average, or
    • the non-HCE average plus 2%.

When the ADP test fails, the typical correction is refunding salary deferrals back to plan HCEs until the test passes – which is never popular with employees serious about retirement savings. Now, there are ways around this through a Safe Harbor 401(k), but we are going to stay out of the weeds and stick to the basics for now. If you’re an overachiever, you can read more about safe harbor in our blog, Safe Harbor 401k Plans: Answers To Common Questions.

While 403(b) plans are subject to a special Universal Availability Rule, they are not subject to the ADP test. This means all of your employees, regardless of their pay, can maximize their salary deferrals annually without fear of refunds.

Still not sure? Ask yourself these 3 questions


If the majority of your answers point to a certain plan type, you have your answer. Now that the hard part is done, now it’s time to find a service provider. I can help with that too! Check out our Shopping Companion to find a competent service provider for your plan.

See, no meltdowns and frustration necessary!

By figuring out the main differences between 403(b) and 401(k) plans, your decision can be made much simpler. The only question that remains is, how do we get the IRS to simplify writing regulations for these plans? I’ll have to figure that out another day. Until next time.

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