401(a) and 401(k) plans are powerful tools in your retirement planning toolbox. These employer-sponsored retirement savings plans ensure you have a steady source of income during your golden years.
While the two may seem similar at first glance, each plan has significant differences that can impact your retirement savings. Understanding the nuances of these retirement plans can help you maximize your savings in your retirement accounts and achieve your long-term financial goals.
Our guide compares 401(a) vs. 401(k), highlighting their similarities and differences to help you understand your choices and make smart financial decisions.
Understand the Difference Between 401(a) vs. 401(k) Plans
| Feature | 401(a) | 401(k) |
|---|---|---|
| Plan Sponsor | Typically offered by government or nonprofit employers | Typically offered by private sector employers |
| Contributions | Employers make contributions on behalf of employees | Employees make contributions from their pre-tax salary |
| Contribution Limits | Varies depending on the plan and employer | $19,500 (2021 and 2022) – subject to annual adjustments |
| Employer Match | Employer may or may not offer a match | Employer may offer a match on employee contributions |
| Vesting | Employer determines vesting schedule | Employee contributions are always 100% vested |
| Investment Options | Determined by the employer or plan administrator | Employees choose from a range of investment options |
| Portability | Usually portable if leaving the employer | Usually portable if leaving the employer |
| Withdrawals | May have restrictions or penalties on withdrawals | Generally subject to penalties before age 59½ |
| Rollovers | Can be rolled over into an IRA or another eligible retirement plan | Can be rolled over into an IRA or another eligible retirement plan |
| Tax Treatment | Contributions and earnings may be tax-deferred | Contributions are pre-tax; earnings are tax-deferred |
| Required Minimum Distributions (RMDs) | Generally required starting at age 72 | Generally required starting at age 72 |
As you navigate your employer’s retirement savings options, you may come across two related-sounding concepts, the 401(a) and the 401(k). While they share some similarities, they are distinct in several key ways. If you’re faced with deciding which plan is right for you, consider your long-term retirement goals and consult a financial advisor if needed.
What is a 401(a) retirement plan?
You may not be as familiar with a 401(a) plan because only government agencies and specific for-profit and non-profit organizations provide these plans to their employees.
A 401(a) plan is an employer-sponsored defined contribution retirement plan. The name of this plan and the 401(k) derives from the Internal Revenue Code (IRC) section that governs it.
Employers fund this plan and decide on the contribution rates and allocation of funds. In contrast, employee contributions may not be mandatory.
What is a 401(k), and how does it work?
A 401(k) plan is an employer-sponsored savings plan to help you save for retirement while taking advantage of tax benefits. These plans are more well-known since private sector employers offer employees 401(k) plans.
Employers are not required to offer 401(k) plans, but many do since it’s an excellent employee benefit that can attract and retain talented employees. 401(k) plans can effectively save for retirement as contributions are tax-deferred, and many employers choose to match contributions.
How are 401(a) and 401(k) plans similar?
Both plans support employees in building their retirement savings in two ways.
- Employer sponsoring
- Funds are invested
- Regular contributions increase retirement savings
What are the differences between 401(a) and 401(k) plans?
The main differences between 401(a) and 401(k) plans are in the details regarding the following factors.
- Eligibility based on the type of employment
- Tenure requirements
- Participation
- Contribution amounts and limits
- Tax Basis
- Investment options
- Withdrawal rules
Eligibility
The eligibility criteria for a 401(a) plan and a 401(k) plan are primarily based on your type of employment. Government agencies and certain non-profit organizations offer 401(a) plans to their employees, whereas private sector employees are eligible for a 401(k) plan.
Also, age plays a role in eligibility. The Internal Revenue Code mandates that an employee must be over 21 years of age and meet tenure requirements of one year for 401 (k) plans and two years for 401 (a) plans.
Participation
When you become employed at a government position, a non-profit, or a related business that provides a 401(a) retirement plan, you may discover that it’s a mandatory requirement for your position, meaning you can’t opt out of it.
Conversely, you can voluntarily enroll in a 401(k) plan or choose not to participate in this savings option. However, you may want to consult a financial advisor and have an alternate retirement savings plan, such as an annuity, in its place.
401(a) vs. 401(k) Contributions
Contribution limits, amounts, guidelines, and tax regulations vary greatly between the plans. To help you navigate the differences, we’ve broken them down by each topic.
Amounts and Limits
How much you can contribute to a 401 retirement plan differ between plans in terms of the amounts and limits.
Contribution limits for 401(a) plans can vary widely depending on the employer’s chosen contribution method. The maximum amount an employee can contribute to a 401(a) plan can vary based on the plan itself, but the contribution limit for 2023 increased to $66,000.
The 401(k) contribution limits for individuals currently sit at $22,500. The limit increases to $30,000 for individuals 50 or older.
Contribution Methods
The 401(a) plan is a defined contribution plan in which an employer regularly contributes money to an employee’s retirement account. These contributions can be either mandatory or voluntary, and they can take many forms, such as a certain percentage of an employee’s salary or a fixed dollar amount. As with other types of defined contribution plans, the amount an employee will receive in retirement depends on the performance of the investments within the plan.
For a 401(k) plan, contributions come from three sources, the employer, the employee, or a combination of both. Employee contributions are voluntary, and employees determine a percentage of their salary to contribute and invest in their 401(k) accounts. Employers are not obligated to contribute. However, they may offer matching contributions that vary based on company policies.
Tax Basis
For a 401(a) plan, contributions can be made pre-tax or post-tax. By contrast, the money contributed to a 401(k) plan is always pre-tax.
However, most contributions for 401(a) plans are made on a pre-tax basis. These pre-tax contributions are deducted from employees’ income before taxes are taken out, reducing their taxable income.
When a retiree begins to take distributions from their 401(a) plan, the money is taxed at their ordinary income tax rate. This means that the retiree will pay taxes on the amount withdrawn, which includes any contributions made on a pre-tax basis and any earnings on those contributions.
Similarly, a 401(k) plan is considered tax-deferred, which means that the taxes on the contributions are deferred until the employee withdraws the money in retirement.
How do retirement investment options differ between plans?
Employers fund 401(a) plans and determine the investment options available to employees. Since 401(a) plans are often limited to a few investment options chosen by the plan sponsor, they may not always be ideal for every employee’s retirement goals.
In contrast, 401(k) plans typically offer various investment choices, including mutual funds, exchange-traded funds (ETFs), and target-date funds. This flexibility allows employees to choose investments that align with their risk tolerance and long-term retirement goals. Consult a registered investment advisor (RIA) for sound financial advice when deciding how to invest these funds best.
What are the withdrawal rules?
Withdrawal rules for 401(a) and 401(k) plans differ slightly. The Internal Revenue Service (IRS) restricts withdrawals from 401(a) plans until retirement, death, disability, or termination of employment.
In contrast, 401(k) plans offer more flexibility than 401(a) plans. Employees are eligible for withdrawals at age 59½, on reaching retirement age, or after the termination of employment.
For both 401(a) and 401(k), if you withdraw the funds before the age of 59 ½, a 10% early withdrawal penalty may be assessed in addition to income taxes.
What are Vesting Schedules with 401(a) and 401(k) Plans?
Vesting determines how much money in the 401(a) or 401(k) plan belongs to the employee if they leave the company before retirement. The employer sets vesting schedules that vary depending on the company’s policies.
What happens to my 401(a) or 401(k) if I leave my job?
If you contribute to a 401(a) or 401(k) and decide to leave your job, you have a few options available.
- Leave your funds in your former employer’s plan.
- Roll over your funds into an IRA.
- Cash out your funds which requires paying the taxes and the 10% withdrawal penalty.
- Transfer your funds to a new employer’s plan.
Required Minimum Distributions (RMDs)
Retirees are required to take minimum distributions starting at age 72. These distributions are also subject to taxation and are determined based on the retiree’s life expectancy and account balance. RMDs ensure that retirees withdraw a minimum amount from their 401(a) or 401(k) plan each year and pay taxes on those distributions.
Can you have both a 401(a) and a 401(k) plan?
While 401(k) plans are available to most employees, 401(a) plans are only available to certain groups, such as government employees. However, it is possible to have both plans. In rare cases, employers may offer a 410 (a) and a 401 (k) plan, allowing employees to maximize their retirement savings.
Final Thoughts on 401(a) vs. 401(k)
Both 401(a) and 401(k) plans offer significant benefits for employees saving for retirement. While 401(a) plans are ideal for employees in the public sector or non-profit organizations, as they provide greater flexibility and higher contribution limits, 401(k) plans are more commonly used in the private sector and often come with generous employer matching contributions.
Ultimately, the best retirement plan aligns with your financial goals, investment preferences, and lifestyle. Regularly review and adjust your contributions and investment choices to ensure you stay on track toward achieving your retirement goals. By doing so, you can enjoy a comfortable and financially secure retirement.
Leave a Reply