401(a) vs. 401(k) Plans: Here Are The Differences
JA
Summary:
Though both 401(k) and 401(a) plans are useful retirement accounts, they have a number of differences. This includes what employees may be eligible, whether pre- or post-tax dollars are contributed, and whether contributions are voluntary or required by employers.
Saving for retirement is one of the most important financial decisions you’ll make in your lifetime. By understanding how retirement savings plans like 401(a)s and 401(k)s work and how they differ from each other, you can ensure that you have the financial resources to maintain your standard of living during your golden years.
401(k)s and Roth IRAs are popular retirement saving options, but there’s another option that’s not talked about as much: the 401(a). Though all are defined contribution retirement plans, a 401(a) retirement plan is only offered to certain types of employees, usually those who work for educational institutions, government organizations, or nonprofit organizations.
But how does it differ from a 401(k) plan? Read on as we cover the similarities and differences between these two types of retirement accounts, including contributions, investment options, and tax benefits.
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How does a 401(k) work?
A 401(k) is a retirement savings plan sponsored by private employers. Employees can contribute a portion of their paycheck to their 401(k) account before taxes are taken out. The funds in the account grow tax-deferred, meaning that employees won’t pay taxes on the account until they retire and start withdrawing the money.
Employers may also offer matching contributions with a 401(k) plan, which can provide a significant boost to employees’ retirement savings. For example, if an employer offers a 50% match on employee contributions up to 6% of salary, an employee who makes an annual salary of $100k and contributes $6,000 a year will receive an employer contribution of $3,000.
Pro Tip
Many employer 401(k) plans offer the services of a financial advisor or investment advisor to help participants with their retirement planning. Consider taking advantage of this if you ever need extra help with 401(k) management.
How does a 401(a) work?
A 401(a) retirement plan is a qualified retirement savings plan offered by government and nonprofit employers. 401(a) plans are similar to 401(k) plans in that they’re subject to the same rules, including early withdrawal penalties and required minimum distributions at age 70½. Employees who contribute to a 401(a) plan can also be eligible to receive a matching contribution from their employer — up to a certain percentage of their salary.
Like 401(k)s, contributions to 401(a)s come directly out of your paycheck. But unlike 401(k)s, to which you can freely choose to opt in or opt out, employers that offer 401(a) retirement plans can make it mandatory for employees to participate. This means 401(a)s might give employers more control over your retirement funds, compared to traditional 401(k) accounts.
401(a) vs. 401(k): Main differences
The 401(k) is one of the most popular types of retirement savings plans in the United States, but it’s not the only option. Another common plan is the 401(a), which has a few key differences from the 401(k).
Who offers 401(a) vs. 401(k)?
Perhaps the most notable difference between the two is the type of employer that offers each plan. 401(a)s are offered by educational institutions, government organizations, and nonprofit organizations. The types of employees who participate in 401(a) plans are usually administrators, teachers, or government employees and support staff.
On the other hand, 401(k)s are typically offered by companies in the private sector.
Contributions
Another major difference between 401(a) and 401(k) plans is the way contributions are set up.
With 401(a)s, employee contributions can either be mandatory or voluntary, depending on the employer. Employers can also decide whether those contributions are made with after-tax dollars or pre-tax dollars. In terms of the employer contributions, they can either add a specific amount to the employee’s account, match the employee contribution with a fixed-dollar amount, or match it with a fixed percentage.
However, employers who offer 401(k)s typically give employees the freedom to choose whether or not they’d like to participate. Employees also have the power to decide how much they want to contribute to the account. Moreover, unlike 401(a)s where the employer has full control over whether the contributions are made on an after-tax or pre-tax basis, 401(k) contributions are generally made with pre-tax dollars.
Pro Tip
As you get closer to retirement, it’s important to make sure that you have enough saved up to cover your costs. To get a better idea, try using a retirement savings calculator to see how much you need to save each year to reach your retirement goal.
Investment options
When you participate in a 401(k) plan, you generally have a choice of how to invest your contributions. 401(k) plans offer a selection of investment options, including company stock, bonds, and mutual funds. You may also have the option to invest in a target-date fund, which is a fund that automatically rebalances itself over time based on your age and retirement goals. In general, most 401(k) plans will provide at least three investment choices.
With 401(a)s, employers are also responsible for picking the investment choices for employees. However, compared to traditional 401(k)s, 401(a) plans typically offer less variety in terms of investment options.
If you want to learn more about your investment options, you may want to speak with a brokerage specializing in those areas. Take a look at some of the options below to get started.
Taxes and benefits
As mentioned above, when it comes to 401(a)s, employers have control over whether your contributions are made with pre-tax or after-tax dollars. But, if you’re enrolled in a 401(k) retirement plan, your contributions are typically made with pre-tax dollars. In other words, the money in your 401(k) account will grow tax-deferred. This means won’t have to pay taxes on the interest or capital gains until you withdraw the money from the account.
It’s worth noting that whether you have a 401(k) or a 401(a) account, you could be eligible for the saver’s tax credit. Depending on your income level, the tax credit is either 10%, 20%, or 50% of your contributions (up to $2,000). This means you can claim a tax credit of up to $1,000.
To be eligible, you must be at least 18 years old and cannot be claimed as a dependent on another person’s tax return. And, if you’d like to claim this tax credit, you can fill out Form 8880 to report the contributions you’ve made to your retirement account.
Pro Tip
Employer-sponsored retirement plans should only be one of the many retirement vehicles you have. Always go beyond your 401(k) or 401(a) contributions and spread your assets over multiple investments — whether that’s real estate, cryptocurrency, or a side business.
FAQs
Is a 401(a) better than a 401(k)?
When it comes to retirement savings plans, there isn’t really one option that’s better than the other. It all comes down to your personal financial goals.
A 401(k) typically allows you to choose from a wide range of investment options, which is great for diversifying your savings portfolio. On the other hand, some 401(a) plans require all employees to make mandatory contributions, which means you’re always saving for retirement, even if you didn’t initially plan on doing so.
It’s important to note that a 401(a) is not available to everyone. It’s usually only offered to employees who work in government agencies or nonprofit organizations.
What are the benefits of sponsored retirement savings plans?
Sponsored retirement savings plans, such as 401(k)s and 401(a)s, are a great way to save for retirement. Not only do they often offer tax advantages, but they also allow you to invest your money in a variety of ways — especially with 401(k)s.
Also, many employer-sponsored retirement savings plans offer matching contributions, which can help you reach your retirement goals even faster. So, if you’re looking for ways to save for your golden years, start by looking into employer-sponsored retirement accounts.
Can I withdraw money from my 401(a)?
Yes, you can withdraw money from your 401(a) account. When you decide to leave your job, you can choose to roll over your 401(a) funds into another retirement plan or take out a lump sum amount.
However, it’s important to note that if you opt for lump-sum distribution from the account, any withdrawals made before the age of 59½ will be charged with a 10% penalty fee.
Key Takeaways
- 401(k)s are typically offered by private sector employers, whereas 401(a)s are offered by public employers. These include government agencies, educational institutions, and nonprofit organizations.
- Employee participation can either be voluntary or mandatory in 401(a) plans. However, 401(k) plans typically allow employees to choose whether or not they’d like to contribute.
- If you contribute regularly to a 401(k) or 401(a) account, you might be eligible for the saver’s tax credit.
- You can incur a 10% early withdrawal penalty fee if you withdraw money from your 401(k) or 401(a) account before you reach the age of 59½.
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