- 401(a) plans are employer-sponsored retirement plans reserved for those working in government, education, or nonprofit sectors.
- Employers have leeway in choosing who gets to participate in 401(a) plans, as they are not required to offer the plan to all employees. Employer contributions are mandatory, and the employer can elect to make employee contributions mandatory as well.
- Although 401(a) and 401(k) plans are similar, there are critical differences between them. Understanding these differences can help you reduce taxable income and maximize earnings by the time you reach retirement age.
If you’re thinking of saving for retirement or perhaps you’ve been at it for a while, there’s a strong chance you’ve heard of a 401(k), an employer-sponsored retirement plan. There is a similar retirement savings plan, a 401(a), your employer may offer you instead. While the 401(k) is quite popular, 401(a) plans are less well-known.
Today, we’re here to provide you with important details you need to know about 401(a) plans, including a 401(a) versus 401(k) comparison. After reading this article, you will have a much clearer idea of how these plans may fit into your personal retirement savings plan.
What Is a 401(a)?
A 401(a) is a tax-deferred retirement savings plan. A 401(a) is established and sponsored by employers. Both employer contributions and employee contributions are allowed under this plan. The sponsoring employer sets:
- Either dollar-based or percentage-based contribution limits
- Eligibility requirements
- The vesting schedule (this defines when employees gain complete control of contributions by the employer into the employee’s accounts)
Employer contributions are mandatory under a 401(a) plan. Employees are not always required to contribute to the plan; this depends on how the employer designs the 401(a). Employees can roll 401(a) funds over to another retirement contribution plan, like an Individual Retirement Account (IRA) or 401(k), when changing jobs.
Who Uses a 401(a) Plan?
The Internal Revenue Code says that 401(a) plans are maintained for employees of:
- The United States government or related agencies
- State or other public employers such as schools and certain non-profit employers
- Indian tribal governments
In addition to government agencies, nonprofit organizations and educational institutions are the two sectors which are likely to offer 401(a) plans. Employers in these sectors tend to provide 401(a) programs along with other types of retirement accounts, like a pension plan. It’s very unlikely to see employers offer standalone 401(a) programs.
Employers can use 401(a) plans as a way to target top talent. Corporations can offer stock options as an investment choice, while small business owners could offer an ownership share. Those working in government, education, and nonprofits don’t have such a luxury. So, 401(a) plans provide employers an option of offering customized benefits to selected employees.
One of the reasons this is possible is because 401(a) plans are not subject to discrimination testing like 401(k) plans are. Discrimination testing is the government’s way of ensuring that highly-compensated employees and non-highly compensated employees are eligible for the same benefits. Because the limitations do not exist for 401(a) plans, employers have leeway in determining what constitutes an eligible employee.
Take a public school district as an example. In addition to the state-funded pension teachers receive, the employing county could elect to offer certain administrators or teachers access to a 401(a) plan to pad their retirement income. The top talent in the state may be more likely to want to work in the county that offers a 401(a) plan than one that does not.
Who Contributes to a 401(a) Plan?
Employer contributions are mandatory under a 401(a) plan, but employee contributions may not be. Although employee contributions are not a standard requirement of 401(a) programs, some employers may require mandatory contributions from employees. If the employer does not mandate contributions, employees may still contribute voluntarily.
If employee contributions are allowed, the employee can usually elect to contribute pre-tax dollars (like a traditional 401(k) or IRA), where income tax is charged upon withdrawing, or as an after-tax investment vehicle (like a Roth 401k or IRA), where income tax is charged before depositing.
The employer is responsible for setting the minimum and maximum contribution amounts. However, these amounts cannot exceed the limits set forth by the Internal Revenue Service (IRS). For 2019, the IRS maximum annual allowable contribution to a 401(a) plan is $56,000 or 100% of the employee’s income, whichever is smaller. Unlike some other retirement accounts like IRAs, employees older than 50 cannot make catch-up contributions to their 401(a).
401(a) v. 401(k)
It helps to understand different types of plans when retirement planning. One of the other popular retirement accounts is a 401(k), a retirement savings plan sponsored by an employer. So, how does a 401(a) plan compare to a 401(k) plan? Below, we’ll examine some of the critical differences between the two.
One of the significant differences is how employers and employees make contributions. Under a 401(k) plan, contributions are entirely voluntary. Neither the employer or employee needs to make minimum distributions. Contributions under a 401(a) program are mandatory for the employer and could be mandatory for the employee.
As mentioned earlier in this article, 401(k) plans are subject to regulation regarding discrimination. Discrimination testing ensures that both high-earning and non-high earning employees are eligible for the same benefits. If an employer offers a 401(k) plan, everyone in the company must have the option to utilize it.
However, a 401(a) is not subject to such testing. Therefore, the employer can offer the plan to a small subset of employees, using the program to help attract top talent.
Generally speaking, 401(a) investment options tend to be more conservative and carry less risk, as designed by the employer. 401(k) plans, on the other hand, tend to have many more investment options, such as domestic and global stocks, ETFs and mutual funds that allow the employee to determine how much risk to take in exchange for expected returns.
401(a) and 401(k) Similarities
Although a 401(a) and 401(k) plan have fundamental differences, the two plans also share a few similarities.
Both 401(k) and 401(a) plans allow employees to contribute either pre-tax or after-tax gross income (from salary and wages). While making contributions to a 401(k) with pre-tax dollars, earnings on the account grow tax-deferred. Tax dollars are owed only when withdrawing funds. If the employee makes after-tax contributions, employees pay taxes when depositing funds, but they can enjoy their contributions and earnings tax-free at withdrawal.
The 401(a) and 401(k) withdrawal rules are the same. Both 401(k) and 401(a) plans have early withdrawal penalties. Under both programs, you cannot withdraw money before you’re 59 1/2 years old. If you do, you’ll pay a 10% early withdrawal penalty in addition to income taxes. The exception to this is after-tax employee contributions (not earnings) which can be withdrawn without income tax or penalties.
Furthermore, both plans qualify employees for the Retirement Savings Contributions Credit, otherwise known as the Saver’s Credit. This tax credit allows you to take tax deductions for making eligible contributions to your retirement account. A few specific criteria limit eligibility for the credit to those who are:
- At least 18 years old
- Not a full-time student
- Not claimed as a dependent on another person’s tax return
Things to Consider When Choosing a Retirement Investment Account
So, which plan is best for you? As an employee, you’re limited to what your employer chooses for you. If you work in a government agency, nonprofit, or educational industry, you may have access to a 401(a). These 401(a) plans are useful, because employers are required to contribute to them, even if the plans have limited selectivity since only certain employees are invited to participate. If your employer offers the plan to you, strongly consider funding it (if it isn’t already mandatory).
If your employer doesn’t extend this selective plan to you, note that the 401(a) is not the only qualified retirement plans that employers in the government, education, or nonprofit sectors can offer. See if your employer also offers the 403(b) or 457 plan. The 457 plan allow for higher contribution levels later in your career, and withdrawals before the age of 59 1/2 are not subject to a 10% penalty (rules apply).
Consult with a financial advisor when retirement planning to review plans your employer offers and which one is best for you. Talking to a financial advisor can help you maximize earnings, and provide guidance for investing for retirement.
Your financial advisor can help you maximize contributions wherever possible to take advantage of either tax-deferred or tax-free growth. An excellent goal is saving 20% of your take-home pay. You can learn more by using our 50/30/20 budget template.
If you have access to a 401(a), consider making contributions if allowed to maximize your retirement savings in a way that offers tax advantages to you, now or later. The last thing to keep in mind is to make sure your retirement account is working for you. Take time to learn how to invest your retirement funds — either on your own or with a financial planner — according to your goals and risk tolerance. Doing so can optimize your savings as you design the retirement and financial future you want.