401a: What Is It and How It Different than a 401k?
Posted by Frank Gogol
Updated on April 28, 2022
If you are a young working professional, you probably know how many people have a strong opinion about 401 retirement plans. If you have just started working for a company, everyone from your dad to Buzzfeed has probably told you that you need to start a 401(k).
What you may not know is that if you work in government, education, or nonprofit organizations, you might be eligible for a 401(a) retirement plan.
A 401(a) retirement plan has different advantages and disadvantages to a 401(k) plan. Below we will see how the type of plan you choose will affect your contributions, investment choices, and tax situation.
Table of Contents
What is a 401 Retirement Plan?
Section 401 of the U.S. Internal Revenue Code sets up two primary types of retirement plans. 401 Retirement Plans help you to build up savings for your retirement. You pay a percentage of your paycheck into the plan every month. This is known as your contribution. Often, your employer will contribute to your retirement plan as well.
This type of defined-contribution retirement plan is beneficial for two reasons. Firstly, you are incentivized to start saving for your retirement, which will serve you well in the long run. Secondly, your employer’s contribution is often over and above your paycheck. An employer’s 401 contribution is a part of your benefits package and is used as an incentive to encourage you to stay at the company.
How 401(a) Plans Work
The 401(a) retirement plan is normally covered by government agencies, educational institutions, and nonprofit organizations. If you are a government employee, teacher, administrator, or support staff, you are likely to be eligible for a 401(a) plan.
A 401(a) plan is usually custom-designed by the organization. This gives your employer a large amount of control over the plan. The employer decides what stocks the plan will invest in, the vesting schedule, and how much of your salary you have to contribute to the fund.
Here are the basics of how a 401(a) plan works:
- Contributions – The employee contribution amounts are usually set by the employer. Contribution to the plan is mandatory.
- Vesting – A vesting schedule is a timeframe an employee has to wait for before being able to access the funds. Vesting is usually used to encourage employees to stay with an organization for a certain amount of time.
- Investment choices – The plan’s investment choices are determined by the employer. They tend to be limited. In particular, government-sponsored 401(a) plans tend to include only the safest, most conservative investment options. This means that investments in 401(a) plans are low risk and typically focus on value-based stocks.
How 401(k) Plans Work
A 401(k) retirement plan is usually offered by private-sector employers. In contrast to a 401(a) plan, you as the employee tend to have more control over your contributions and investment choices.
Here are the basics of how a 401(k) plan works:
- Contributions – Your contribution to a 401(k) plan is voluntary. You can contribute as much or as little as you want (within IRS guidelines). Your employer often will match up to a certain percentage of your contribution.
- Vesting – Usually, a 401(k) plan does not have a vesting schedule, meaning that all of the funds in the plan are immediately accessible to you.
- Investment choices – You get to choose your investment options from a wide range of options provided by your employer.
401(a) vs. 401(k): Eligibility
Your employer determines your 401(a) or 401(k) eligibility. If you don’t work for a government agency, educational institution, or nonprofit organization you are not eligible for a 401(a) plan. If you are a government employee, teacher, administrator, or support staff, you are likely to be eligible for a 401(a) plan. If you are working for a for-profit organization, you are likely eligible for a 401(k) plan.
Because the employer has so much control over a 401(a) plan, eligibility for the plan will vary across your organization. In a for-profit organization, every full-time employee within the company is eligible for a 401(k). A 401(a) plan, on the other hand, is sometimes only offered to specific employees as an incentive to continue working with the organization.
Your age will also affect your eligibility. You need to be at least 21 years old. You also need to have spent a set amount of time at your company to be eligible for these plans. For a 401(k) you usually need to have been with your company for at least one year. For a 401(a), you usually need to have been with your company for at least two years.
Contributions to a 401(a) vs. 401(k)
With a 401(a) plan, your employer has control over your contributions, and these rules can differ from company to company.
Your employer will decide whether:
- Contributions are mandatory or voluntary
- Contributions are made after-tax or pre-tax
- It will contribute a fixed amount or match your contributions.
On the other hand. employer contributions are mandatory with a 401(a).
In a 401(k) plan, you have more control. You can choose your contribution amounts. You can choose whether you want to contribute to a traditional 401(k) plan for pre-tax contributions or a Roth 401(k) for after-tax contributions.
As of 2020, you can contribute up to $19,500 annually to a 401(k). With a 401(a), you can contribute up to $57,000.
401(a) vs. 401(k): Taxes
The tax implications of your retirement plan will depend on whether your contributions were made after-tax or pre-tax.
After-tax contributions are already taxed. They do not count as tax credits and do not decrease your taxable income. You still get a tax benefit, though. When you withdraw money from the retirement plan, you will not pay additional tax.
Pre-tax contributions decrease your taxable income. If you voluntarily contribute to your 401 retirement plan, you are also eligible for a tax credit. When you withdraw money from the retirement plan, those withdrawals will be taxed at that time.
If you have a 401(a) and an Individual Retirement Account (IRA), your tax benefits for IRA contributions may be phased out depending on your adjusted gross income.
Your 401(a) withdrawals are subject to income tax withholdings and a 10% early withdrawal penalty.
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You might not have a lot of choices when it comes to the retirement plan your employer offers. But whether you are eligible for a 401(a) or a 401(k), it is important to take full advantage of the plan your employer offers.
Make sure that, as much as possible, you choose the contribution schedule that will be most advantageous. Maximize the contribution made by your employer. Contribute voluntarily to qualify for tax credits. Choose investment options that suit your needs.
Your retirement is something you need to think about now. Be aware of your options, and choose the strategy that will work best for you.
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