401(k) Plan vs 401(a) Plan

401(k)

401(k) is a qualified employer-provided retirement plan that is designed to allow you the opportunity to invest money for your future. Although 401(k) accounts are not taxed until they are withdrawn at retirement, there are several important factors to consider before investing in one.

First, it can be expensive to have a 401(k). Some employers will charge up to 100 dollars just to sign up for the plan. Other employers will offer to match your 401(k) contributions, but this is not always a good idea. 

Second, you are limited in how much you can contribute annually. For many years the maximum 401(k) contribution was 100 percent of your income or $16,500, whichever was lower. For more recent tax years, the maximum contribution is $18,000.

401(a)

401(a) is a 401(k) alternative that is available to non-profit employees. The primary difference between a 401(k) and a 401(a) plan is that the 401(a) plan does not allow for employer matching contributions.

This means it can be much cheaper than a 401(k) because you are only responsible for paying the investment fees associated with your account. Also, there are fewer eligibility requirements for 401(a) plans.

Since 401(a)’s are so similar to 401(k)’s, many financial experts recommend a 401(a) plan as a supplement to a 401(k). If you have a 401(k), it is important to contribute enough money each payday so that you receive the maximum employer matching contribution from your employer. Many employers will offer to match your 401(k) contributions up to 6 percent of your income.

Although 401(a) plans do not allow for employer matching, they are very flexible when it comes to saving money. This is because you can contribute any amount of money on a pre-tax basis, regardless of how much you make. 

For example, if you earn $30,000 per year, you are 100 percent taxed. However, if you contribute 10 percent of your income to a 401(a) plan each pay period, only $27,000 will be subject to federal tax. This means that up to $3,000 can go into your 401(a) before being taxed!

However, 401(a)’s have several downsides. First, you are responsible for paying all of the investment fees associated with your account. This is often more expensive than a 401(k) because 401(a) usually requires you to invest in mutual funds instead of ETFs.

Second, if you decide to make withdrawals before retirement age or leave your job before retirement, 401(a) plans are subject to early withdrawal penalties.

Another downside to 401(a)’s is that some employers will not allow you to contribute more than 6 percent of your income per year on a pre-tax basis. This can make it difficult for individuals who want to save money each month because they do not qualify for the maximum contribution limit.

It is important to note that 401(a) plans do allow for in-service distributions. This means that if you have a 401(a) plan and leave your job, you can rollover your 401(a) balance to an IRA or other employer-sponsored retirement account.

Differences Between 401(k) and 401(a)

  • 401(k)’s have higher fees, while 401(a) plans have less stringent eligibility requirements.
  • 401(k)’s allow employer matching contributions if you are employed by a large company, while the same is not always true for a 401(a) plan.
  • 401(k) accounts are subject to an early withdrawal penalty, but 401(a) plans are not.
  • 401(k) plans allow for in-service distributions, but 401(a) plans do not.

Similarities of 401(k) and 401(a)

  • Both allow pre-tax contributions
  • Both require a dollar for dollar tax on distributions 

Pros and Cons of 401(k)

Pros of 401(k)

First, let us examine the pros of a 401(k). The primary benefit is that it allows employees to receive an employer match if they contribute a certain percentage of their income. This means that you can potentially double your investment from year to year without increasing the amount that you are contributing from your paycheck each payday.

In addition, 401(k) accounts have slightly higher contribution limits than traditional IRAs. For example, in 2015 you can contribute up to $18,000 to a 401(k) plan.

Finally, it is very easy to set up a 401(k) retirement account. All you have to do is fill out some paperwork at work and your employer will automatically enroll you in the plan.

Pros of 401(a)

Next, let’s analyze the pros of using a 401(a) plan. The main benefit is that you can contribute a maximum of $18,000 pre-tax per year no matter how much you make. For example, if you earn $30,000 and contribute 10 percent to your 401(a) each year, you reduce your taxable income to $27,000. This is extremely beneficial for individuals who live paycheck to paycheck because they can save more money without having to contribute a significant portion of their income each payday.

On top of this, 401(a) plans often have lower fees than 401(k) plans. This means you can potentially increase your retirement savings by thousands of dollars simply by switching to a 401(a) plan and maintaining the same monthly contribution amount.

Finally, 401(a) plans are extremely flexible when it comes to withdrawals. Unlike 401(k) plans, you are not required to take distributions once you reach the age of 70 ½. This means that you can leave your money in an account indefinitely without having to worry about severe tax penalties later in life.

Cons of 401(k)

The primary drawback of 401(k)’s is the lack of employer matching. Many employers do not offer 401(k)’s to employees, which means you are left with only your contributions to live off of.

Another downside of 401(k) plans is that they often restrict the types of funds you can invest in. For example, 401(k) plan providers typically only allow investors to choose from a list of up to 10 mutual funds instead of offering access to thousands of different ETFs like you would find on an IRA.

The final drawback is that 401(k) plans do not allow for in-service distributions. This means that you are required to leave your job before withdrawing any funds or risk facing massive early withdrawal penalties.

Cons of 401(a)

As mentioned earlier, there are several types of 401(a) plans. The main drawback is that not all 401(a)’s are created equally. Some employers will only allow you to invest in a provider-selected fund, which usually has higher fees and lower returns than other types of investments.

In addition, some 401(a) plan providers do not offer investment advice. In order to make the best decisions for your financial future, you need access to professional advice. If your employer does not offer financial planners or other types of advisors, opening an IRA account is the best way to give yourself more control over your retirement savings.

Lastly, 401(a) plans often require you to leave your money in for a certain amount of years before withdrawing. For example, many 401(a) plans mandate one-year minimum holding periods. This means you would have to leave your money untouched for a full 12 months before you can make any withdrawals without facing steep early withdrawal fees.

Choosing Between 401(k) and 401(a)

The best option is usually going to be a 401(k) plan, but if you do not have options, then a 401(a) might be your best bet. If given the opportunity, choose a 401(k) over a 401(a) because the fees and penalties are lower.

However, it never hurts to go for what is available; especially if that means saving on taxes while investing in your future. Consider all available options and choose the plan that fits best with your current lifestyle. 

In order to pick a retirement account, you have to consider the following: how much do I want to pay in fees? How much can I afford per month? What withdrawal rules does my 401(k) or 401(a) have?

If you are considering saving for retirement, then you should look into opening a 401(k) or 401(a) account. If your employer offers matching contributions it is definitely worth looking into, but if not there are still other options available to you.

Final Word

If you have an option between a 401(k) and 401(a), always go with the one with lower fees. If you have a 401(k) with your employer, always take advantage of the matching contributions. The only time you should choose a 401(a) is if you don’t have any other options.

In conclusion, 401(a)’s are advantageous to those who want the most control over their own retirement. 401(k) plans benefit those who want as little hassle as possible and can take advantage of employer matching contributions. 

This plan is also known as a qualified plan and is 100% employer-sponsored. The employee pretax contributions are deducted from their pay before calculating income tax, which means it reduces taxable income for the year.
This type of retirement account is offered by nonprofit organizations, such as universities. It allows employees to make pre-tax contributions and the employer usually matches the contribution.
The main difference is where you can invest your money. 401k's typically offer more investment options than 401(a) plans; however, some employers only offer investors access to a small number of limited funds with their 401(a), which provides fewer opportunities for growth.
401(k) offers more investment options; however, they also generally charge higher fees than other types of retirement accounts. Employer matching contributions can help offset high fees. You will be required to pay taxes once you start making withdrawals during retirement (when you are no longer employed).
The main benefits of a 401(a) include no mandatory withdrawals and access to employer matching contributions. However, you will be limited in terms of your choice of investments - as with most nonprofit organizations, their funds tend to be more conservative than those used by for-profit organizations.

401(k) Plan | A Complete Beginner's Guide

401(k) Meaning

The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k). Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.

Traditional 401(k) vs Roth 401(k)

There are two types of 401(k) plans: Traditional and Roth 401(k)s. The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978. With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn. Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006. Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free. Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings. Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.

Contributing to Your 401(k) Retirement Plan

Contributing to a 401(k) plan is traditionally done through one’s employer. Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion. If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade. If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion. To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn. With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them. Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire. If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term. You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket. On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true. In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up. Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change. A smart move may be to hedge your bets and divide your contributions between the two types of IRAs. If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each. In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other. When you do decide which avenue to take, make sure to thoroughly evaluate your decision. Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible. Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky. You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.

Pension vs 401(k)

Pensions are similar to a 401(k), but are a liability to a company. If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement. There is typically no option to grow this amount, but it also does not require any financial investment from the employee. Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer. 401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.

How Much Should I Contribute to My 401(k)?

Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k). There are limits on how much you can contribute to it that are outlined in detail below. There are two methods of contributing funds to your 401(k). The main way of adding new funds to your account is to contribute a portion of your own income directly. This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)). The system mandates that the majority of direct financial contributions will come from your own pocket. It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return. The second method comes from deposits that an employer matches. Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee. However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan. This is especially important to keep in mind if you want to utilize both types of plans. A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year. For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000. If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions. The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.

Plan in Advance

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401(k) Plan FAQs

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.