Tax Withholding and Reporting for a 401(a)

When you sit back and imagine what your future retirement will look like, you may envision a second home by the beach or a lot of time to finally pursue a hobby that's always been in the back of your mind. You probably don't imagine yourself scrambling for money to pay for medications or looking for a job to support yourself after retiring from your career. Sadly, that's the reality for many retirees who didn't have an adequate savings plan for retirement. Unless you're nearing retirement age, you may not have to deal with the pressing concerns that come along with it. However, planning for retirement is a long process for most people, and it’s never too early to start saving. Choosing an employer that offers a smart savings plan can be a great first step.

While most people have heard of traditional 401(k) retirement plans, there’s another lesser-known plan in the 401 category that your employer may offer. A 401(a) is a benefit of some jobs that allows you to acquire lifetime retirement income. So, by investing well in a savings plan such as a 401(a), you empower yourself to one day retire with a financial cushion that offers you the freedom to do more of what you want when you’re no longer working a 9-to-5 job.

A 401(a) retirement plan is a tax-deferred retirement savings plan that’s established and sponsored by an employer. Indian tribal governments, universities, nonprofit organizations and United States government agencies often offer them. 401(a) plans are especially popular among educational institutions and libraries. As the employee, you can make dollar-based or percentage-based contributions. With a 401(a), your employer makes contributions whether you choose to also contribute from your salary or not. Happily, the contributions made by the employer who offers a 401(a) plan are often larger than the matching programs companies often offer with 401(k) plans.

Overall, a 401(a) savings plan is a lot like a 401(k) savings plan. With a 401(a) plan, you may choose and change the beneficiaries for your account. For example, if you are married to someone when you start your savings plan and list him as a beneficiary, you are allowed to change the beneficiary if you get divorced or later decide you want to change it for other reasons. Also, pick from a variety of investment options and determine which payout options work best for your financial health. Tax withholding and reporting rules must be followed as strictly as they are with any other retirement plan. Your place of employment must follow current tax criteria that pertain to making and reporting deductions from your paycheck.

Vesting and Your Tax Withholding

With a 401(a) retirement plan, your employer establishes the vesting schedule, and employers sometimes use the 401(a) as an incentive to retain valued employees. Vesting means that you have to work for a specific number of years for your employer before you are able to attain full ownership of their contributions to your 401(a) plan. So, you essentially have a promised benefit that won’t become yours unless you stick with the company until you’re fully vested. That vesting schedule may be based on graded vesting or cliff vesting. With graded vesting, you get ownership a bit at a time over a certain number of years. With cliff vesting, you have full vesting after a certain number of years have passed.

Taxes can be a little confusing for many people with vested retirement plans. However, the rules are pretty straightforward. You are only responsible for paying taxes on a vested benefit if what you receive is taxable. For example, your employer’s contributions to your 401(a) retirement plan are not likely to be taxed since they are often considered pretax withholdings. When the contributions from an employer are vested, the same applies. You don’t report the money on your return because it’s not taxable.

The IRS states in IRC section 414(h)(2) that any government unit’s established plan will have the employee contributions treated as the employer’s contributions if the employer “picks up” such contributions. In other words, certain criteria need to be met for an employee’s contributions to count as that of the employer. The IRS has set a series of rulings that state what qualifies as employer contributions. For employee contributions to be “picked up” or made by the employer, the contributions must be paid by the employer even though they are designated as employee contributions. Also, starting on the date that the employer makes the contributions, the IRS doesn’t permit an employee to attain cash or deferred election right when it comes to designated employee contributions. So, the employees cannot opt out of the "pick up" or receive the money directly in lieu of contributions to the 401(a) plan.

Voluntary vs. Mandatory Contributions

With a 401(a) retirement savings plan, your consent is actually not necessary for your employer to arrange your participation. In addition to the contributions your employer arranges to make, a 401(a) can be partially funded by your voluntary or mandatory deposits. You may be surprised by how much of your salary can be used for contributions to the retirement savings plan. They can add up to a quarter of your total compensation from your job. Although this may seem daunting, the 401(a) plan is all about helping you, and it is a perk that attracts many potential workers to an organization that offers high employer contributions.

Pretax Withholding for a 401(a)

Some employers offer pretax withholding on your 401(a) plan contributions, while others offer after-tax withholding for contributions. In some cases, you may have the option to save in both ways. When contributions are mandatory, they are usually pretax, which reduces your taxable income during the pay periods where you would make a contribution to the 401(a) retirement plan. In most situations, you also don’t pay state taxes. Simply put, your employer’s 401(a) plan will empower you to defer some of the money you earn from being taxed by putting it in the retirement account. So, at the time that it is placed in the account, you won’t pay taxes on it beyond FICA taxes.

You’re only allowed a certain amount of additional contributions that are exempt from taxes unless they’re made according to specific elective deferral provisions. If your contributions don’t meet those standards, they’re treated as regular income, so you’ll be taxed on them.

If you fund your retirement account with pretax funds, you pay income taxes later when you withdraw the money. Also, if you later decide to withdraw funds from the plan before you are 59 ½ years of age, you might incur an early withdrawal penalty of 10 percent. Always fully consider the 401(a) withdrawal rules before taking money out of the account. Both 401(a) taxes and withdrawals require careful consideration. For example, you don't want to make specific plans for your retirement based on the full amount you have in the account because you won't take home that much due to being taxed upon withdrawal. It's important to consider all possible taxes and fees when looking at how much money you will be able to realistically access when you retire.

Withholding of FICA Taxes

If your employer offers pretax funding, the employer does withhold FICA taxes, which are Medicare and Social Security taxes, but you don’t pay federal income tax on the payroll deduction. So, deposits to your 401(a) retirement plan that are taken from your salary are subject to FICA taxes, although the deposits made directly by your employer that are not deducted from your salary are not subject to FICA taxes. For the 401(a) employer contributions to not be subject to withholdings for Social Security and Medicare taxes, the employer contributions need to be extra compensation, not compensation that is deducted from the salary. So, it needs to be considered a salary “supplement” to apply. Also, it must be mandatory for all the employees of the company, organization or institution who are covered by the retirement system. The employer cannot simply offer it to one or two specific employees.

After-Tax Withholding for a 401(a)

If you have after-tax contributions for your 401(a), your employer withholds income taxes, Social Security taxes and Medicare taxes. Unlike pretax funding, after-tax contributions don’t offer you tax savings when the money is deducted from your paycheck. However, if you withdraw money from the account, you don’t have to pay income taxes on the amount you withdraw if it is a qualifying withdrawal. For retirement plans there are rules for withdrawal, so you have to follow certain criteria for taking money out after you’ve contributed it to the plan.

W-2 Matters for Your 401(a)

Your employer is required to report the wages you’ve earned and the taxes withheld on those earnings each year on Form W-2 from the IRS. Your employer then files the form with state and local agencies as well as the Social Security Administration. Your employer also gives a copy to you. When it’s time to file your taxes each year, properly reporting your 401(a) contributions is very important. So, be sure to look over the completed W-2 form you receive from your employer. As you’re doing so, consider how your W-2 form is filled out. Confirm that your employer put an “X” in box 13 on your W-2. This box concerns retirement plans and marking it lets the IRS know that you participated in such a plan. Your employer does not include your pretax payments as part of your taxable wages in Form W-2’s box 1. On the other hand, after-tax payments are included in box 1.

Did your employer take out state income tax? If so, your state wages in box 16 need to show your contributions. On the other hand, if your employer didn’t withhold the state income tax from your contributions, then box 16 shouldn’t include your 401(a) contributions. Since you did pay the FICA taxes (the Medicare and Social Security taxes), make sure that boxes 3 and 5 show your payments as your Social Security and Medicare wages. Your employer may put employer contributions, employee contributions or both in box 14 of the W-2 form. The information in box 14 is for your reference.

Investment Options

How wise is a 401(a) retirement plan? Does the interest earned surpass the money you could make by saving your money in other ways? Choosing the most effective savings plan is one concern for anyone who is trying to save for long-term goals, such as retirement. Since many 401(a) plans are often sponsored by government agencies, universities, nonprofit organizations and other educational institutions, the employers may exercise more control than an employer who offers a 401(k) plan might exercise. Because of this, you may find that conservative choices are often made for your retirement savings plan. The investment may be limited to a small number of mutual funds and other options. You may be limited with the investment options, but oftentimes the larger contributions that are possible with a 401(a) plan make up for the drawbacks potentially associated with it.

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