You’re likely familiar with the term 401(k), but unless you work for a public agency, you may not know about 401(a) plans. The 401 in both instances refers to a section of the Internal Revenue Service Code. In the case of the 401(a), the employer has a lot more latitude in making decisions than in other types of retirement plans.
The 401(a) Plan
401(a)s are used by government agencies, nonprofit organizations and educational institutions, and are also known as money purchase plans. Those working for federal, state, local or tribal government entities may have the option to contribute to a 401(a). Both public and private schools, colleges and universities may offer this plan to workers.
In many cases, the employee must choose between funding a 401(a) or deciding on a government pension. For the employer, the 401(a) offers considerably more leeway than other types of retirement plans, as the IRS sets fewer limitations on the 401(a) than on other plans.
The employer forms the 401(a) plan, and each plan has its individual vesting criteria, contribution limits and employee eligibility. The employer determines the investment options. In effect, the employer can custom tailor a 401(a). The employer also decides whether contributions for employees are mandatory or voluntary and whether such contributions are pretax or after-tax. If the employee contributions are mandatory, they are made on a pretax basis. That lowers the amount of an employee’s income for tax purposes. If the contributions are voluntary, they are made on an after-tax basis and do not lower the employee’s taxable income.
However, the employer is mandated to make contributions to the employee’s plan, even if the employee does not want mandatory contributions on their part taken from their paycheck. The employer may either put a certain amount of money into the employees’ account or match employee contributions via a certain percentage or dollar amount. It’s also up to the employer as to whether the 401(a) plan allows employees to tap into their retirement savings for a loan. If the employer does permit such an option, it’s a good one for their workers, as the IRS allows employees to borrow as much as $50,000 from their 401(a). There are caveats, of course. The IRS requires that the money is paid back, with interest, within five years.
Vesting in a 401(a)
With a 401(a), the worker doesn’t have to wait for their contributions to become fully vested. That happens immediately. However, the employer sets up their own vesting schedule for the contribution they make. Usually, the employer contributions are vested based on years of service, much like other types of qualified retirement plans. Because employees may have to wait several years before such vesting, it gives them an incentive to stay on the job.
Much like 401(k)s, the IRS charges a 10-percent penalty on 401(a) withdrawals made before the employee reaches the age of 59.5, unless the person is disabled or has died. When an employee dies, their 401(a) account goes to their named beneficiaries. A married employee’s 401(a) account must go to their spouse unless the spouse specifically waives the distribution via a written form. The employee must begin taking minimum distributions from their 401(a) account by the time they reach 70.5. These amounts are taxable upon withdrawal if they were made with pretax income. You do not have to pay taxes upon withdrawal for contributions made with after-tax income. If your 401(a) includes both pretax and after-tax income, you must keep careful track of your contributions to differentiate between the two when it comes to withdrawals.
401(a) Investment Options
As noted, the employer makes the decision regarding 401(a) investment options. As the employer is a public or nonprofit agent, however, those investments tend toward the more conservative, at least when compared to offerings from other types of employer-sponsored retirement plans. While such conservative options are less risky, they also don’t tend to perform as well over the long haul as more aggressive investments. Conservative investments are a good idea for those employees close to retirement age, but younger employees who are at a stage where they can handle more risk and volatility in return for potentially higher returns are at a disadvantage with most 401(a) investment options. Employers often choose target date funds as a sort of default for their workers. The employer may offer choices from only a single mutual fund family, so the employees' investment opportunities are limited to that fund’s stock, bond, money market and offerings.
401(a) and Rollovers
If an employee leaves the employer, they may roll over their 401(a) into an IRA and escape the 10-percent IRS penalty if they have not reached retirement age. Employees may also roll over their 401(a) plan into a 401(k) plan if they take a job in the private sector.
The Difference Between 401(k) and 401(a)
A 401(k) is offered to employees of private companies rather than those working in the public sector, as with the 401(a). A person with a 401(k) can decide how much she wants to contribute, unlike the 401(a). An employee with a 401(k) generally can choose between a range of investment options, while the employer decides the options for the employee with the 401(a). For most workers, the 401(k) forms the backbone of their retirement plan. That may prove true with some 401(a) employees, but this plan is more often offered as an incentive to retain employees by the employer. Such plans are thus generally offered only to key employees, not everyone. While many private employers do match their employees’ 401(k) contributions up to a particular limit, they are not legally bound to do so.
One huge difference between a 401(k) and a 401(a) is the amount of money an employee may contribute to the plan. For the 401(k), the current amount is up to $18,500 annually, while for the 401(a) the amount is $55,000. While an employee cannot contribute more than they earn to their 401(a), they can, however, contribute their entire salary. If a person is married and has a spouse making a comfortable living, the couple may decide it’s worthwhile for the spouse with the 401(a) to put all of their salary, up to the $55,000 limit, into the 401(a). Most people aren’t in that situation, but for those lucky few, it’s a great advantage.
The Difference Between a 401(a) and 403(b)
The 401(a) and 403(b) are very similar, but the 403(b) is designed for those working for nonprofit organizations, public schools and certain members of the clergy. Unlike the 401(a) for the most part, the 403(b) is subject to annual contribution limits, and there are limits as to how much the employer may contribute. For 2018, the employee contribution limit is $18,500. If an employee is aged 50 or over, he can make catch-up contributions with a 403(b). While an employee with a 403(b) account may make withdrawals without penalty upon reaching age 55, 4.5 years earlier than those with a 401(a), the penalty for such withdrawals before age 55 is a whopping 20 percent.
The 403(b), like the 401(k), are considered core retirement plans offered by an employer. A 401(a) may work as either a core or supplemental retirement plan for the employee, depending on the eligibility requirements set forth by the employer.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Zack's, Financial Advisor, nj.com, LegalZoom and The Nest.