Traditional 401(k) plans are a primary workplace savings vehicle, as they offer an easy and tax-efficient way to build a nest egg for retirement. However, there is a lesser-known retirement savings plan worth considering: the 401(a) plan.
“Most people have never heard of a 401(a),” says Drew Kellerman, founder of financial firm Phase 2 Wealth Advisors in Gig Harbor, Washington. That’s because they are often limited to key personnel within an organization and usually only found in the government, education and nonprofit sectors.
While not everyone is eligible to receive a 401(a) plan, it’s crucial to understand the key differences, benefits, drawbacks and provisions of each option to maximize the value of your retirement savings account. Read on to brush up on the basics of each employer-sponsored plan, including their tax incentives, contribution limitations and opportunity for investment growth.
[See: How to Pay Less Tax on Retirement Account Withdrawals.]
What is a 401(k) plan?
A 401(k) account is a popular workplace savings account offered by many private employers. There are two 401(k) plan options: traditional and Roth 401(k)s.
Contributions made to a traditional 401(k) account are eligible for an immediate tax deduction, meaning you’re not subject to regular income tax until you make withdrawals in retirement. And with a traditional 401(k), retirees are required to begin taking minimum distributions at age 70 ½. Roth accounts, on the other hand, are funded with after-tax contributions, and withdrawals in retirement are tax-free. What’s more, there are no required minimum distributions with a Roth 401(k). However, withdrawals made from both traditional and Roth 401(k) accounts prior to age 59 ½ may be subject to a 10 percent penalty.
Employers who want to offer 401(k) plans to workers are subject to nondiscrimination testing, explains Troy Dryer, vice president of business development for Investment Provider Xchange, a company offering cloud-based technology for retirement plans. This testing ensures the savings accounts don’t unfairly favor certain employees. If a 401(k) plan is provided, employers must offer the same terms to all eligible workers.
For instance, some employers will match the contributions of employees up to a certain percentage. While businesses are not required to offer a match, if they do, they must offer the same percentage match to all workers. Employees can’t be forced to contribute to a 401(k) account and the amount of any contribution they make is solely at their discretion.
What is a 401(a) plan?
Unlike a 401(k) plan, a 401(a) plan allows employers to offer customized benefits for selected employees. “Employers might not want to hassle with the discrimination testing in a 401(k) plan,” Dryer says, and with a 401(a) plan, they don’t have to go through the process.
The use of 401(a) plans is largely limited to the government, education and nonprofit sectors. In many cases, the plans are used in conjunction with a pension or other retirement account and offered as a perk to draw top talent to an agency. “You would almost never see a 401(a) without another type of plan offered,” says Kyle Webber, managing partner with advisory firm Quartz Partners Investment Management in Troy, New York. A 401(a) might be offered to key personnel in the same way stock options may be extended to business executives.
When employers set up 401(a) plans, they are required to make contributions. They can also mandate that employees make contributions as well. Mandatory contributions are made with pre-tax dollars, while workers also have the option of making additional deposits with after-tax money. Keep in mind, withdrawals in retirement are subject to income tax and money pulled from the account prior to age 59 ½ may be subject to a 10 percent penalty.
[Read: How Much Should You Contribute to a 401(k)?]
How to Compare 401(a) vs. 401(k) Plans
Both 401(a) and 401(k) plans are authorized by the same section of the tax code. “They are extremely similar in their makeup,” Webber says. A key distinction is how each savings plan is structured as well as eligibility and contribution requirements. While no worker can be forced to contribute to a 401(k) plan, employees may be required to put money into 401(a) plans. Up to $56,000 in combined employee and employer contributions can be made to a 401(a) plan in 2019.
Those with a 401(k) plan can contribute up to $19,000 of their own money in 2019, but like 401(a) accounts, the combined total of employer and employee contributions cannot exceed $56,000. Workers age 50 and older are entitled to make an additional $6,000 in catch-up contributions to a 401(k) plan and can have up to $62,000 in total in employee and employer deposits.
As for investment options, employees typically have greater control in a 401(k) plan regarding which funds to place their money. Conversely, 401(a) plans often have more limited fund choices, if any at all. Both types of plans may have vesting requirements that ensure a person works for a certain period of time before gaining access to employer contributions made on their behalf.
With both 401(a) and 401(k) plans, workers can rollover their balance into a new retirement account or IRA if they leave their workplace. While each option provides valuable benefits, “the 401(k) has more flexibility for employees,” Kellerman says.
Not only do the plans typically allow workers a greater number of investment options, but they also come in traditional and Roth versions. Being able to choose between a traditional or Roth account can be useful when it comes to tax planning for retirement.
[See: How to Max Out Your 401(k) in 2019.]
Still, if you’re offered a 401(a) plan in addition to a pension or other retirement account, don’t turn it down. Anytime an employer is willing to deposit money into a fund for your retirement, it’s a smart move to accept it.
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401(a) vs. 401(k): What Is the Difference? originally appeared on usnews.com
