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401(k) Versus 401(a): Comparing Retirement Plan Options

Much press is given to 401(k)s, but other options exist for employer-sponsored defined contribution plans. A 401(a) goal is similar to a 401(k) but has some important differences when determining the most suitable retirement plan for your needs.

The 401(k) plan is widely used in the private sector, while the 401(a) program is commonly offered by government, educational, and non-profit employers. 

The key differences between these plans lie in their eligibility, employer and employee contributions, vesting periods, distribution rules, and tax treatments, which directly impact how you save and invest for your retirement.

 

Key Takeaways

  • 401(k) is prevalent in the private sector, whereas 401(a) is offered to government and non-profit workers
  • Differences include eligibility, contribution rules, vesting periods, tax treatments, and distribution guidelines
  • Careful consideration of these differences is critical in choosing the right retirement plan for one’s needs

 

Understanding 401(k) and 401(a)

401(k) and 401(a) plans are employer-sponsored retirement plans that offer tax advantages to participants. However, some critical differences between the two can impact eligibility, contribution limits, and investment options.

 

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What is a 401(k)?

A 401(k) is a retirement savings plan commonly offered by private-sector employers in the United States.

401(k)s are designed to facilitate and encourage employee retirement savings. It allows employees to contribute a portion of their pre-tax income into the account, reducing their current taxable income. Employees can choose how much income to set aside each month, and employers may match some (or all) contributions up to a certain limit.

Investment options within a 401(k) plan are typically employee-directed, with various choices, such as mutual and target-date funds. Withdrawals from a 401(k) are taxed as ordinary income upon retirement, and participants must be at least 59.5 years old to withdraw without penalty.

 

Key Features of 401(k):

 

Employer Matching Contributions

One notable feature of the 401(k) plan is the potential for employer-matching contributions. Many employers offer to match a portion of an employee’s contribution, often up to a certain percentage of their salary or a specific dollar amount. This can significantly incentivize employees to contribute and maximize their savings.

Employers set rules for who can participate in the plan and how much they will match the employee contributions. Once you leave employment, you can no longer contribute to your account. Employer contributions to your account may take several years to vest fully, so if you leave your current employer, you may have to forfeit some or all of your employer’s contributions to your account.

Employers are not required to offer retirement plans. Those offering plans can provide either traditional 401(k)s or Roth 401(k)s. Contributions made to conventional accounts are made on a pre-tax basis, giving you an immediate reduction in taxable income.

For traditional accounts, you’ll pay taxes on any distributions from the account. Roth contributions are made on a post-tax basis, but withdrawals are tax-free.

 

Investment Options

Typically, employees have a range of investment choices within their 401(k) plan, including stocks, bonds, and mutual funds. This allows individuals to create a diversified portfolio that aligns with their risk tolerance and financial goals. Some 401(k) plans also offer target-date funds, automatically rebalancing the invested assets as the employee approaches retirement age to minimize risk.

 

Contribution Limits

Contributions to 401(k)s are limited by annual limits. In 2023, employees can contribute up to $22,500 to their account each year, and employees over age 50 can contribute an additional catchup contribution of $7,500.

Current rules allow the catchup contribution to be made on a pre-tax basis. Starting in 2026, catchup contributions must be made to Roth accounts. The Internal Revenue Service (IRS) may update these limits annually to version for inflation.

 

Contribution Limits

In 2023, the maximum contribution to a 401(a) is $66,000 or 100% of the participant’s income, whichever is lower.

 

Withdrawals

Generally, withdrawals made before age 59 and a half are subject to a 10% early-withdrawal penalty and income taxes due on the withdrawn amount. However, exceptions exist, such as hardship withdrawals and qualified expenses like medical bills or first-time home purchases. Some 401(k) plans also allow loans to be taken from the account’s balance, though repayment terms and potential penalties can apply if repayment conditions are met.

 

What is a 401(a)?

401(a) is a lesser-known retirement account. These plans are offered by public sector employers and play a key role in retirement planning for public sector employees. 401(a)s may be offered by government entities, educational institutions, and some non-profits.

 

Key Features of 401(a):

 

Employer Matching Contributions

Unlike a 401(k), which allows employees to choose how much they contribute, many 401(a) plans have mandatory employee contribution rates, although not all employees are required to participate. Some plans also allow for additional, voluntary contributions. The additional rules mean that employees may have less control over their contribution levels than in a 401(k) plan.

Both employers and employees must contribute either a fixed dollar amount or a fixed percentage of the employee’s income.

 

Investment Options

Investment options for 401(a) plans may be more limited than those available in a 401(k) plan and could be employer-directed rather than employee-directed.

The range of investment options may vary in 401(a) plans, but the employer typically decides on the available investment choices. Employees have the opportunity to select from these pre-determined choices to suit their risk tolerance and investment goals.

 

Vesting

Vesting refers to the employee’s ownership of the funds contributed by the employer. In a 401(a) plan, the employer determines the vesting schedule. The schedule may offer immediate vesting or require specific years of service before an employee fully owns the employer’s contributions.

 

Withdrawals

Like a traditional 401(k), contributions to a 401(a) are usually made pre-tax, lowering an employee’s taxable income in the current year. Distributions from these plans are taxed at the time of withdrawal. In recent years, some 401a plans have started offering post-tax contributions, which would lead to tax-free withdrawal in retirement.

401(a) plan participants must generally wait until they reach the age of 59 ½ to withdraw funds without incurring penalties. Withdrawals before the eligible age are subject to a 10% early withdrawal penalty and are taxable as regular income. However, there are certain exceptions, such as disability, which may qualify for penalty-free withdrawals.

 

Key Differences Between 401(k) and 401(a)

 

Eligibility and Participation

Which plan your employer offers is determined by your employer type.

401(k) plans are available to a broader range of employees. In contrast, 401(a) plans are generally limited to specific groups of employees, such as government workers and certain employees of educational institutions and nonprofits.

Employers are not required to offer either plan. In most cases, employees can freely choose to participate in a 401(k) plan, whereas participation in a 401(a) plan may be mandatory for eligible employees.

Employees become eligible to participate in a 401(a) after two years of service. Private employers can put a waiting period of up to two years for a 401(k), but this option is rarely used.

 

Contributions

401(k) plans offer much greater flexibility for employees and employers. A 401(k) allows employees to choose how much they will contribute (up to the annual max), and employees can change their contributions throughout the year.

Employers also benefit from the flexibility of 401(k) plans. In a 401(a) plan, employer contributions are mandatory, while employee contributions may be voluntary. On the other hand, 401(k) plans allow employers to match employee contributions and make additional, discretionary profit-sharing contributions.

 

Contribution Limits

With significantly higher contribution limits, 401(a)s are preferable to 401(k) plans. The maximum contribution to a 401(a) is $66,000 in 2023. The $66,000 limit applies to the combined employer and employee contributions. So in a 401(a) plan, an employee can contribute up to $66,000 less their employer’s contribution. In a 401(k) employee contributions are limited to $22,500. Your employer may limit your contributions further based on a percentage of your income although the combined employee and employer contribution cannot exceed $66,000.

 

Investment Options

Both 401(k) and 401(a) plans may offer a range of investment choices. Employer-sponsored plans usually have limited investment options, which is true of both plans.

However, 401(k) plans generally offer a wider range of investment options than 401(a) plans.

In a 401(k) plan, employees can usually select from a menu of investment options, including mutual funds, stocks, bonds, and more. 401(a) plans tend to have fewer options and may focus their investment choices on government bonds and value-based stocks.

 

Vesting Periods

Employee contributions are always fully invested in both plans.

Both 401(k) and 401(a) plans may have their own vesting schedules, which determine when an employee has full ownership of employer contributions.

Employers will establish a vesting schedule for employer contributions to either account type.

The vesting period can vary depending on the specific plan, with some plans offering immediate vesting and others requiring several years of service before an employee becomes fully vested.

 

Withdrawals

Both types of plans allow you to rollover your contributions into an IRA upon leaving employment. 401(a)s typically have the option of converting your plan balance to an annuity in retirement.

Pre-tax contributions to either plan are subject to early withdrawal penalties of 10% if the contributions are distributed before you turn 59.5, although there are some ways to avoid this penalty.

 

401(k) Pros and Cons

 

ProsCons
Employees have the freedom to choose how much to contributeSometimes limited in investment choices
Potential for a generous employer matchPenalties for early withdrawal
The benefit of the Roth option

 

401(a) Pros and Cons

 

ProsCons
Regular and consistent contributionsEmployee contribution rate is set by the employer
Tailored for niche employee groups, such as government institutions and educational organizationsObligatory contribution mandates
Potential post-tax options if offered by the employerPenalties for early withdrawal

 

Final Thoughts

Ultimately, you won’t be able to choose between a 401(k) and a 401(a) plan since your employer determines which plan is available to you. Either plan offers you a way to start making considerable contributions on either a pre- or post-tax basis to your retirement. Employer contributions will help you maximize your savings and build a more considerable nest egg.

 

Frequently Asked Questions

 

How do contribution limits vary between 401(a) and 401(k) plans?

Both 401(a) and 401(k) plans have annual contribution limits, but these limits can differ.

For 401(k) plans, participants can generally contribute a percentage of their salary up to a maximum annual limit of $20,500 for 2023. In contrast, the maximum employee contribution to a 401(a) is $66,000 less the employer contribution (or 100% of your salary, whichever is less). Employers also have the option of setting lower maximum contribution limits. They may include mandatory contributions, matching contributions, or both, making the potential total contribution higher than that for a 401(k) plan source.

 

Can you roll over a 401(a) plan to another retirement account?

In most cases, it is possible to roll over a 401(a) plan to another qualified retirement account, such as a 401(k), 403(b), or an IRA, when leaving a job or retiring. It is essential to consult with a financial advisor before rolling over a 401(a) plan to ensure a smooth and tax-efficient transfer.

 

What are the tax implications of 401(a) and 401(k) plans?

401(a) and 401(k) plans offer tax advantages to participants. Contributions to these plans are typically made pre-tax, lowering taxable income during the contribution years. In addition, earnings on investments within the plans grow tax-deferred until they are withdrawn during retirement source. Upon withdrawal, the funds are taxed as ordinary income.

 

How do withdrawal rules differ for 401(k) and 401(a) accounts?

Withdrawal rules for 401(k) and 401(a) accounts are similar; however, some minor differences may apply. Participants in both plans generally must not withdraw funds until they reach age 59 ½, or they may face a 10% early withdrawal penalty.

However, exceptions may apply for specific hardships, first-time home purchases, or higher education expenses source. It is always recommended to consult with a financial advisor or tax professional before considering withdrawals from either type of retirement account.

 

What happens to a 401(a) plan upon leaving a job?

When leaving a job with a 401(a) plan, participants generally have the option to keep the funds in the existing plan, transfer the funds to a new employer’s retirement plan, or roll over the funds into a qualified retirement account, such as an IRA. Understanding the specific rules and potential tax implications associated with each option source is crucial. Discussing these options with a financial advisor or tax professional is advised for the best possible outcome.

 



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1 thought on “401(k) Versus 401(a): Comparing Retirement Plan Options”

  1. Very helpful article. I am considering working for the federal government as a civilian employee after I leave military service, I was not tracking the vesting period. I will have to stay with the government a minimum of three years to meet the vesting period, even after over 20 years of military service (which does not count toward civilian vesting periods, unless you were a civilian employee before the military service). I was not aware of this yet, not a huge issue, but good to know.

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