Let’s stay together: How employer nonelective contributions to a 403(b) plan may retain employees

Written by Linda Segal Blinn

School districts face challenges in attracting and retaining treasurers. A properly structured employer nonelective contribution feature to the school’s 403(b) plan may be an attractive incentive for a treasurer to remain with the school district. 

What is an employer nonelective contribution to a 403(b) plan?

When an employee elects to contribute to a 403(b) plan, that employee completes a salary deferral agreement to identify the amount or percent of compensation that will be contributed to the plan, either as a pre-tax or (if permitted in the 403(b) plan) Roth contribution. These employee deferrals are considered to be cash or deferred arrangements — meaning, that the employee has the right to determine whether to have such amounts contributed to the 403(b) plan or to receive the amounts as compensation.

On the other hand, an employer nonelective contribution to a 403(b) plan is not a cash or deferred arrangement. The employer determines the amount or percent of the contribution to be made on behalf of eligible employees. Those eligible employees do not have the right, directly or indirectly, to receive that employer nonelective contribution as compensation instead.

Is there an annual limit on the amount of the employer nonelective contribution?

Yes, the Internal Revenue Code provides that the annual total of all employee contributions (other than the Age 50+ catch-up) and employer contributions to a participant’s 403(b) account cannot be more than 100% of compensation up to a stated dollar amount (in 2024, $69,000 and subject to annual Internal Revenue Service (IRS) cost of living adjustments).

How should employer nonelective contributions be remitted to the 403(b) plan’s investment providers?

Since an employer nonelective contribution is not a deferral of employee compensation, a school district should remit employer nonelective contributions as a separate contribution source to the 403(b) plan’s investment providers.

Employer nonelective contributions should not be commingled with employee contributions that are subject to a salary deferral agreement for the following reasons:

• IRS Form W-2 reporting 
  • Employee deferrals to a 403(b) plan must be reported in Box 12 (“Codes”) of the IRS Form W-2 in the year contributed. However, employer nonelective contributions may — but are not required to — be reported in Box 14 (“Other”) of the IRS Form W-2. The IRS cautions in its instructions to the Form W-2 that nonelective employer contributions made on behalf of an employee “are not elective deferrals and may be reported in box 14, but not in box 12.”
• Payroll taxes
  • Employee deferrals (whether pre-tax or Roth) are subject to Social Security (if applicable), Medicare, and Federal Unemployment (FUTA) taxes. Because employer nonelective contributions to a 403(b) plan are not considered wages, they are not subject to those payroll taxes.
• Eligibility for the 15 Years of Service Catch-up Contribution.
  • This catch-up, if permitted under the 403(b) plan, is calculated in part based on prior years’ deferrals made by the participant to the 403(b) plan. Employer nonelective contributions are not taken into account for this calculation.

How does a school district add an employer nonelective contribution to a 403(b) plan?

A school district may add an employer nonelective contribution by amending its 403(b) plan document to:

• Identify the employees who meet the criteria for having an employer nonelective contribution allocated to their accounts (as defined by the plan). Employees who are eligible for an employer nonelective contribution may choose not to contribute elective deferrals to the 403(b) plan. 
• Determine the annual contribution formula. IRS guidance permits an employer nonelective contribution to be made to eligible participants under a discretionary contribution formula or a definite contribution formula (expressed as a percent or dollar amount of compensation).
• Establish the vesting schedule for the employer contribution (will the employer nonelective contribution be fully vested when contributed or be subject to vested percentage based on years of service with the school district)

The amendment to the 403(b) plan should be:

• Approved by a school board resolution authorizing the amendment of the 403(b) plan to add the employer nonelective contribution; and
• Adopted by an individual authorized to sign the amendment on behalf of the school district no later than the end of the plan year in which the employer nonelective contribution was first effective.

Best practice ideas: 

• Work closely with legal counsel to develop an employer nonelective contribution feature that meets the school district’s 403(b) plan design objectives and applicable law.
• Keep the amended 403(b) plan document and board resolutions in a secure, readily accessible location. An IRS agent auditing a school district’s 403(b) plan may ask the school district for a copy of the executed 403(b) plan document and any amendments. Remember that the IRS generally audits three years back from the current tax year, so be sure to retain records at least three years from the current tax year.
• Develop human resources and payroll protocols to ensure that employees eligible for the employer nonelective contribution are not provided with any choice or option — in any documents or in actual operation — to receive the employer nonelective contribution as cash compensation in lieu of being contributed to the 403(b) plan.
• Review payroll procedures for appropriate payroll tax and tax reporting treatment of employer nonelective contributions.

Reprinted from the June 2024 issue of SBO Quarterly with the permission of the Ohio Association of School Business Officials.