What type of retirement plan is best for your church: a 403(b)(9) or a 401(k)?
Typically, 401(k) plans are used in the for-profit world and 403(b)(9) plans are strictly for churches or those with 501(c)(3) church status. However, there are 401(k) church plans.
Often, church administrators choose a 401(k) plan because it’s familiar. And many administrators are not even aware that there are other options that may be better suited for their church.
So that leads us to our next question. Is a 401(k) church plan the best option for a church? Or is the 403(b)(9) better suited for churches?
In this article, we lay out some of the main reasons why 403(b)(9) plans are generally the best option for churches.
How are 401(k) church plans different from 403(b)(9) church plans?
We know that 403(b)(9) plans are designated for the specific needs of churches or those with 501(c)(3) church status.
And although 401(k) plans are often used in for-profit companies, churches can establish a 401(k) church retirement plan.
So, when making a decision between the two, how do administrators know which one to choose?
Here are some of the big differences you will find between 401(k) and 403(b)(9) church plans:
Not Subject to ERISA Regulations
Let’s start with a unique benefit that both plans fall under: neither plan is subject to ERISA regulations (unless elected).
For 403(b)(9) plans, this means they are not required to file Form 5500 and are not subject to discrimination testing — saving both cost and time.
401(k) church plans also do not have to file Form 5500. However, they may be subject to ADP, ACP, and top-heavy testing.
It’s important to note that 401(k) plans must initially declare their plan as “non-church” in order to be exempt from ERISA regulations. If this is not done in the beginning, it could be irrevocable.
Minister’s Housing Allowance
Both 403(b)(9) and 401(k) church plans offer a big tax break for pastors — the ability to claim housing allowance.
Housing allowance lets ministers exclude a portion of their gross income (spent on housing allowances) from federal and state income taxes. It’s money that is reported as income; thus, the minister’s taxes are reduced, not deducted.
Not only can ministers make tax-free contributions (for the portion that is designated as housing allowance) to their retirement plan, but they can also take that money out tax-free in retirement.
The most significant difference between the two plans is that claiming housing allowance on 403(b)(9) plans is much easier.
Since 403(b)(9) plans are designated church plans, participants make the housing allowance election on their distribution form and report their housing expenses each year.
For 401(k)s, the plan must be designated as a church plan and it must permit housing allowance designations on distribution. Again, it’s critical that administrators initially make a statement that designates the plan as “non-church” or non-ERISA. If this was not done, it could be irrevocable and pastors cannot take housing allowance.
Thus, using a 403(b)(9) over a 401(k) plan is always recommended for churches. And frankly, it is simpler and easier to modify.
Flexibility with eligible employees
Ok, let’s talk eligibility. Who can participate? And do the same rules apply to both plans?
Let’s start with 403(b)(9) plans. If you’re an employee of a church, you’re eligible to participate in their 403(b)(9) plan (subject to the final plan documents). However, these plans are not subject to nondiscrimination rules so the employer has the flexibility to choose who can participate in the plan. This means that the employer can use participation restrictions, such as age, years of service, or position.
While 401(k) plans are less restrictive than non-church 401(k) plans, they do not have the same exclusion rights as 403(b)(9) plans. 401(k) church plans cannot exclude those who exceed age 21, have one year of service, are union employees covered under collective bargaining agreements, and are non-resident aliens with no U.S. income.
The flexibility that 403(b)(9) plans have over 401(k) church plans is a clear advantage.
Contributions
The contribution limit (and additional catch-up contributions) for both plans are the same.
As of 2023, employees can defer up to $22,500 per year. And employee and employer contributions per employee cannot exceed $66,000 (unless the employee is 50 or older).
However, 403(b)(9) plans have some advantages over 401(k) church plans when it comes to contributions.
What are they?
For starters, there’s a difference in limits when contributing to multiple retirement plans. For 401(k) church plans, all contributions are aggregated within the 401(k) to one limit of $66,000.
403(b)(9) plans, on the other hand, allow contributions to 401(a) and 403(b) plans to exceed the $66,000 limit.
Another 403(b)(9) benefit is this: employees of “qualified organizations” with 15 years of service may be eligible to contribute an additional $3,000 each year (up to a lifetime limit of $15,000). There are also special contribution limits for missionaries and employees who earn less than $17,000 per year.
One of the biggest differences is that employer contributions in a 403(b)(9) plan can continue even after the employee terminates service. This rule allows contributions to be made for up to five years for the terminated employee. For example, a church could decide to continue 403(b)(9) contributions for its senior pastor, even after retirement.
It’s important to note that only the church can make these contributions — not the former employee.
Timing of deferrals and penalties
To avoid penalties or extra costs, salary deferrals, loan payments, and after-tax contributions must be deposited on time. Once these payments are withheld from employee paychecks, they become plan assets and should be deposited as soon as administratively possible.
So, what happens if the plan administrator is late? For 401(k) plans, administrators must file Form 5330 and the IRS will apply a 15% excise tax on the late deferrals.
For 403(b)(9) plans, deferrals should be paid as soon as possible. However, these plans are less strict on deposit timing rules. Form 5330 is not required and the 15% excise tax does not apply. Instead, the employer must fund the late amounts and pay the lost earnings.
Investment options
There’s a bit of a misconception that 401(k) church plans have more investment options than 403(b)(9) plans. This simply isn’t true. Both plans can choose a wide variety of investments. The biggest difference is that 403(b)(9) plans often opt to include biblically responsible funds as well.
Still have questions?
Making the best decision on what type of retirement plan is best for your church can feel overwhelming. There are a lot of rules, regulations, and benefits to consider (many of which can be hard to understand).
At TruthPoint Financial, we know that retirement planning can be a complicated topic. That’s why we’re here to help ease your mind and choose the best path for you and your church.
Reach out if you have any questions. We’d love to help.