Retirement represents a major milestone that we all look forward to in our lives. But what happens after retirement may prove as important as the lead-up to it!
A successful retirement takes careful planning, discipline, and diligence. These factors can make the difference between a comfortable retirement and one that barely meets your basic needs.
What’s more, the type of retirement plan can impact the relative shine of an employee’s golden years. Almost everyone has heard of a 401(k); but, few know about the 401(a) offered by governments and non-profit organizations. While these two retirement accounts remain similar, a difference between 401(k) and 401(a) exists regarding contributions and investment options.
What Is a 401(a)?
Typically, 401(a) retirement plans serve as part of the benefit packages offered to employees by state and federal government agencies, educational entities, and other non-profit organizations.
Employers dictate the size of the mandatory contributions that employees must make each month; and, said contributions may or may not receive a tax assessment at the time of transfer.
Motivating an employee to stay with an organization represents one of the main purposes of a 401(a). To further this end, the employer dictates the amount contributed by the employee and the dates on which the 401(a) becomes fully vested. As additional motivation for the employee to stay on, the employer also makes mandatory contributions on behalf of the employee.
Investment choices remain limited with a 401(a), especially plans offered by government agencies. Government 401(a) plans limit speculation and allow only the most secure investment types. Keep this in mind when thinking about a 401(a) versus 401(k).
What Is a 401(k)?
The ubiquitous 401(k) serves as the main retirement plan for employees working in the private sector. With 401(k) plans, employees get to choose how much they want to contribute each month. However, the Internal Revenue Service (IRS) sets maximum limits.
Employees with a traditional 401(k) can contribute money to their retirement account before taxes and utilize a tax deduction on their tax returns based on the amount contributed.
Individuals with a Roth 401(k) contribute funds that have already been taxed and receive no deduction. However, a Roth 401(k) provides greater flexibility regarding early withdrawals.
Employers that offer 401(k) plans decide the investment types available to employees and allow them to choose from various options. Usually, private employees will have a wider selection of investment choices than people with a 401(a). Employers often match their employees’ contributions even though no mandate exists under the law that forces them to do so.
Difference Between 401(k) and 401(a)
Although 401(k) and 401(a) accounts operate in a similar manner, several important differences do stand out. Some of the distinctions between 401(k) and 401(a) plans have to do with:
- Investment options
Let’s take a closer look at each of these differences in turn.
As mentioned above, 401(k) and 401(a) plans differ when it comes to who contributes and contribution limits. These variations impact the ultimate size of retirement accounts and give employees something to think about when considering a career change.
Who Contributes to a 401(k)?
A 401(k) plan represents a completely voluntary scheme. Employees have a right to choose whether or not they participate and an employer can not force them to contribute. And, employees can decide how much of their pre-tax salary they’d like to put towards their 401(k) every month.
Many employers match the contributions of their employees up to a certain limit. The law does not require employers to contribute to their employees’ 401(k) accounts; so, they get to decide how much they’d like to match. Usually, employers match a small percentage of their employees’ monthly salary.
Who Contributes to a 401(a)?
Under the law, employers offering a 401(a) plan must contribute towards their employees’ retirement account. However, employers have the option of paying a percentage of their employees’ salaries or a fixed amount. They also have discretion over eligibility requirements and vesting schedules.
Like the 401(k), employee contributions to a 401(a) are voluntary. Those that do choose to pay into their retirement accounts may pay a percentage of their monthly salaries or a specified amount. Employees can also pause contributions if they need an immediate increase in their cash flow.
What Are the Contribution Limits for a 401(k)?
For a 401(k), the contribution limits change every year. In 2021, an employee may contribute 100% of the annual salary or $58,000, whichever is less. The first $19,500 contributed lessens an employee’s income for tax purposes. The remaining amount contributed counts as taxable income when filling out income tax returns.
One important exception exists for employees aged 50 or older. For such individuals, the first $26,000 reduces the employee’s income for the year.
Employees can contribute more than the limit; but, such contributions must come from post-tax funds.
Note: Employer contributions count towards the contribution limit. So, the more an employer contributes, the less an employee can contribute before going over the limit.
What Are the Contribution Limits for a 401(a)?
The contribution limits for a 401(a) are the same as those for a 401(k). But, the main difference lies in the fact that the entire amount contributed to a 401(a) reduces an employee’s taxable income up to the contribution limit.
Like 401(k) plans, employer contributions get tabulated towards the statutory contribution limit for a given year.
As discussed earlier, a 401(k) plan has more investment options than a 401(a). Furthermore, a government or non-profit employee may have only one 401(a) investment option. Let’s get into the specific investment options for each retirement plan.
401(k) Investment Options
Because 401(k) plans offer more to choose from, employees must think carefully about where to invest their money. Some of the investment types employees can take advantage of may include:
- Mutual funds
- Exchange-traded funds (ETF)
- Government bonds
401(a) Investment Options
Government, educational, and non-profit organizations usually limit investment options to value-based mutual funds and low-risk government bonds. While the lack of flexibility may frustrate some employees, the conservative choices decrease the risk of significant losses while saving for retirement.
When contrasting 401(a) and 401(k) plans, the penalties, fees, and taxes associated with early withdrawals create several significant distinctions. Sometimes, an employee can withdraw money without losing any of it due to fine print. Other times, an early withdrawal can cause major losses.
To withdraw funds from a 401(k) without a penalty, employees must have attained the age of 55. But, to withdraw money from a 401(a) without incurring a penalty, employees must be 59.5 years of age.
After reaching the age of 70.5, holders of 401(a) accounts must make regular withdrawals.
In order to avoid an early withdrawal penalty, employees with a 401(k) must have retired in the same year they turned 55. Those who have a 401(a) plan do not need to meet this requirement.
While the rules for rolling over a 401(k) and 401(a) into an IRA or other retirement account remain mostly the same, 401(k) plans offer greater flexibility.
Employees can sometimes borrow funds from their 401(k) and 401(a) accounts and pay them back over time if they have a qualified financial emergency. Both account types limit borrowing to $50,000 or 50% of the account balance, whichever is less.
One big difference between 401(k) and 401(a) loans involves taxation. Employees who take loans out of their 401(k) accounts must pay it back with post-tax dollars. When it comes time to retire and start withdrawing money, the IRS will take the withdrawn money, resulting in a double tax.
An additional difference lies in the fact that anyone with a significant financial need can borrow money from a 401(k) account. For 401(a) plans, the employer decides if employees can take out a loan.
In some cases, an employee can’t take out a loan from a 401(a) account at all because the employer does not allow it. When government and non-profit employers do permit loans, borrowers must repay their loans within five years. Failure to do so will result in a tax assessed against the remaining balance of the loan in addition to a 10% penalty.
One nice thing about borrowing from a 401(a) account revolves around accrued interest. Although borrowers must pay interest as mandated by the IRS, the interest payments go back into the 401(a) account. So, borrowers end up paying themselves.
Hi there! Did we forget an important difference between 401(k) and 401(a)? Let us know in the comments and we will add it to the article during our next update.