401(a) vs. 401(k) Plans: What’s the Difference?
As the employer-sponsored defined contribution plan continues to drop out of style (only 7% of employees at small companies and 19% of employees at medium to large companies are offered a defined benefit plan), 401 accounts have become popular. The two most common types of 401 plans you’ll hear about are 401a vs. 401k.
The purpose of these two types of accounts is the same — for young and middle-aged working professionals to continually stock up tax-deferred money into an account that they can draw from after retirement. Many eligible companies offer 401 plans as an incentive; the 401 is the closest employees nowadays can expect to a pension.
The main differences between these two types of retirement plans have to do with eligibility requirements, employer control and employer contribution amounts, and tax advantages. Below, we’ll break down the differences between types of retirement plan contributions and answer all of your basic questions about retirement planning with a 401(a) and 401(k) account.
What is a 401(a) Plan?
401(a) is a retirement plan specifically designed for employees in government, nonprofit, or education industries. Only employees in these fields are eligible for a 401(a). For this reason, these plans are much less common than the popular 401(k). These accounts are highly variable because they grant the employer almost complete power over the account’s vesting schedule, stock options, and mandatory employee contribution amounts.
Still, there are some general characteristics of 401(a) plans that do not change. In general, investment choices, which are employer-controlled, are very limited. The available investments through a 401(a) tend to be conservative and on the safe side. These plans are often custom-designed based on individual employees’ positions, salaries, and expectations. They are commonly offered to employees as an incentive to stay with the company long-term.
While employee participation in a 401(k) program is not mandatory, employees are obligated to contribute to a 401(a). Employer contributions are also mandatory. Employees usually cannot make voluntary contributions of more than 25% of their annual salary. The employer usually matches the amount that an employee stores in the account up to an established limit.
Also, unlike a 401(k), the employee does not control their elective deferral contribution schedule and investment options. Still, this is not seen as a significant risk considering that there is a guaranteed payout and that employers often restrict the plan’s investment option to only the safest value stocks.
Benefits and Disadvantages of a 401(a)
Benefits:
- Employers are subject to mandatory contributions or must match employee contribution amounts to a fixed percentage or dollar amount.
- Contributions can be rolled over, meaning that if the employee leaves their job, they can withdraw contributions by rolling it over to another savings plan (including a 401k) or buying an annuity.
- The account contributions can be either pre-taxed or post-taxed.
- Account-holders get a tax benefit.
- Higher possible contributions.
Disadvantages:
- Mandatory employee contribution.
- The employer controls monthly contributions — the amount the employee must contribute, the schedule of remittances, and whether the contributions are pre-taxed or post-taxed.
- Less choice over stock options.
- Employees with a 401(a) plan cannot make contributions to a 401(k).
401a vs. 401k FAQ
Who is eligible for a 401(a)?
Employees who work in the government, educational, or nonprofit sectors are potentially eligible. Employers in these sectors are not required to offer a 401(a) plan contribution, however. In addition to working in one of the above industries, an eligible employee must be over 21 years of age and have worked at the company for at least two years.
How Much Can I Contribute to a 401(A)?
Contribution limits change year to year to adjust for inflation. The total limit for both an employer contribution and employee contribution in 2021 is $58,000.
What Is the Remittance Schedule?
The remittance schedule is decided by the employer. Depending on the conditions set by the employer, it could be a monthly, quarterly, bi-annual, or annual contribution. Similarly, employers also set the vesting schedule. An employer match schedule that does not pay out until a certain number of years is one way employers increase loyalty with a 401(a) plan participant.
What Kind of Savings Plans Can a 401(a) Rollover Into?
You have many options for rolling over your 401(a) into another tax-sheltered retirement account. If you are hired by another employer in the nonprofit, education, or government sector and who approves of your request, you can transfer the account into the new 401(a). You can also roll over the money into a traditional IRA or Roth IRA, or a combination of the two. An employer who offers a 401(a) plan can place their employee retirement savings into a simple ira retirement account.
What Happens When a 401(a) Rollover Takes Place?
When rolling over a 401(a), it’s important to remember that a pretax employee contribution will often be rolled over into a traditional IRA. After-tax contributions will be rolled over into a Roth IRA.
When Should I Start Making Withdrawals?
Like other retirement savings accounts, the recommended age to start withdrawing from your fund is 59.5 years of age. If you make withdrawals prior to this age, you will be subject to a 10% early withdrawal penalty (this penalty fee can sometimes be waived under IRS hardship withdrawals). You are required to make withdrawals when you turn 70.5 years old. Even if you retire before that age, you will not be required to withdraw funds. Some plans allow the beneficiary to withdraw voluntary after-tax contributions whenever they want or after they reach the “normal retirement age” as designated by the plan’s terms. If you plan well enough, you may even be able to retire early.
What Is the Plan’s Investment Option?
Because this plan is offered through government agencies or nonprofit organizations, the investment option that comes along with it tends to be more conservative than the options that come with a traditional 401(k). Sometimes, a 401(a) plan works with mutual funds or restricts the number of investment options to six to 12 funds. Common stocks that are offered through a 401(a) include single stock funds, bond funds, government bond funds, stable value funds, and target-date funds.
What if I Don’t Consent to a 401(a)?
The employer fixes the terms of this plan. While you can, of course, choose whether to accept the plan, you cannot choose the terms. Suppose you do not voluntarily make elective contributions, and the plan requires that you do. In that case, your employer will contribute on your behalf by withholding money from your paychecks to be deposited into the account.
What is a 401k Plan?
The 401(k) plan is the 401(a)’s more well-known sibling. 401(k)’s are offered to a wider variety of employees. Generally, the 401(k) is offered by a private employer. The biggest difference between the two plans is that with a 401(k), employees have greater flexibility and control — how much they want to contribute, what stock options to invest in, and when they make contributions.
There are two types of 401(k) plans: the traditional 401(k) and the Roth 401(k). Because of key differences between the two plans, some people choose to diversify their retirement savings and have both a traditional and Roth 401(k). Others with more predictable finances may only invest in one type of plan.
In both plans, money is not withdrawn until after the beneficiary reaches the standard retirement age of 59.5. Any contributions withdrawn before this time or before alternative criteria are met will be taxed at 10%.
A 401(k) accrues on a tax-deferred basis through an automatic payroll deduction by the employer. Employees set how much they want to contribute (with limits determined by the IRS, which change yearly).
Most employers then offer to match that amount, often up to 50% of contributions or 2.7% of salary. While technically, an employee can open a 401(k) plan without an employer matching contribution, it is much less preferable, and it may be wise to store your money in a different type of retirement savings plan or supplemental retirement plan.
Traditional 401(k) vs. Roth 401(k)
If you’ve decided you want to contribute to a 401(k) qualified plan, you now have to determine which 401(k) is right for you. The main difference between a traditional and a Roth 401(k) is the way in which they are taxed and when.
Your contributions are pre-tax dollars in a traditional 401(k) plan, meaning that you receive the income tax deduction for contributions upfront. However, upon withdrawal, contributions are considered taxable income and will be taxed according to your income tax bracket during retirement.
A Roth 401(k) is the reverse. Contributions in a Roth account are after-tax, meaning there are no upfront tax benefits. The reward comes later when you start making withdrawals. Contributions in a Roth 401(k) — employer matches and your earnings — are tax-free upon withdrawal from your retirement account (as long as you’ve had the account for at least five years).
401(k) FAQ:
Should I Contribute to a Traditional or a Roth 401(K)? Which Is Better for Me?
This is a highly variable question; the answer will be different for everyone’s unique financial situation. Here are some things to consider if you’re trying to decide where to start storing your retirement money:
- If you are in a low income bracket and you do not anticipate your wage to rise by much, or if you are less than five years away from retirement, go with a traditional 401(k).
- If you are young and anticipate your wages to rise (along with your tax bracket), consider a Roth. Even if you are a low-earner now, your salary might be significantly higher by the time you retire. Because Roth contributions are after-tax, you will not pay taxes on them when you start withdrawing, even if you are in a higher income bracket than you were when you contributed.
The above is only a tip. Only you and your financial advisor can answer this question. And even then, no one can definitively say which option will yield the highest return. Luckily, you don’t have to choose between the two. Many employers offer the chance to invest in both a 401(k) and a Roth. If your future feels uncertain, you may wish to put your eggs in two baskets rather than one.
How Much Can I Contribute to a 401(K)?
The IRS regulates the amount you and your employer can contribute. For 2021, employees cannot contribute more than $19,500. However, the total contribution limit (including employer contributions) is $58,000.
What Is the Remittance Schedule?
Employee contributions are immediately and automatically deducted from their paycheck. Employers must deposit deferrals within five days after each pay period.
What Kind of Savings Plans Can a 401(K) Rollover Into?
If you end your employment, you will have the option to roll over your 401(k) into a 401(k) with another employer (Roth or traditional, depending on what your private sector employer offers). Alternatively, it can roll over into a 401(k) IRA contribution. Your new employer can also set you up with a simple IRA plan if you do not want to do it yourself. If you choose to do nothing, your 401(k) will either stay with your previous employer, or you may be required to withdraw the money.
When Should I Start Making Withdrawals?
You are strongly advised to hold off on withdrawing any money from your 401(k) until you reach the normal retirement age as defined by the IRS, which is 59.5. If you withdraw before this time, you will be taxed 10% on your withdrawal amount. There are some situations where you can withdraw early without a penalty — for example, if you are rendered totally disabled before the age of 59.5. Regardless of when you actually stop working, you will be required to start taking withdrawals when you turn 72.
Final Thoughts
Hopefully, you now understand the pros and cons of a 401k versus 401a. Ultimately, the difference between 401a and 401k comes down to tax benefits and employer contributions. Some people will be restricted from opening a 401a or 401k based on their employer and field of industry.
It’s best to open a retirement savings account as soon as you can. That way, you have the maximum possible time to accumulate money for your retirement years. If you are near retirement and your retirement savings plan is lacking, cash advances are available to help you make it through.
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