401(a): What It Is and How It Differs From a 401(k)

Learn the ins and outs of the 401(a) vs. the 401(k).

When it comes to saving for retirement, defined benefit plans like a 401(k) are a smart way to build wealth and grow your money tax-free. But not everyone is eligible for a 401(k). Some employers offer a similar plan called a 401(a).

A 401(a) plan is an employer-sponsored retirement plan offered by government agencies, educational institutions and nonprofit organizations. In addition to contribution amounts your employer makes on your behalf, 401(a) plans may allow for mandatory pretax employee contributions and, in some cases, voluntary after-tax contributions.

Keep reading to find out how to get the most out of your 401(a).

How Does a 401(a) Plan Work?

All 401(a) plans share basic features, but employers define the specific rules about how their plans work. For example, employers are required to make contributions on their employees’ behalf, whether as a percentage of employees’ earnings or a set dollar amount. Employee contributions, on the other hand, can be either mandatory or voluntary.

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Tax-Deferred Contributions

Mandatory 401(a) contributions are withheld from your pretax income, so you don’t pay tax on those contributions until you withdraw the money.

Voluntary contributions, when the plan allows them, come from after-tax income and are limited to 25% of the employee’s compensation. Qualified withdrawals of your voluntary contributions are tax-free, said Leibel Sternbach, an Accredited Portfolio Management Advisor and founder of the Yields4U retirement education platform.

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401(a) Contribution Limits

The IRS imposes contribution limits on 401(a) accounts. For tax year 2020, the limit is 100% of the employee’s income, less mandatory contributions, up to a maximum of $57,000. Unlike 401(k) plans and individual retirement accounts, 401(a) accounts don’t allow catch-up contributions when investors reach age 50.

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How Contributions Are Made

Your employer puts the deductions it makes on your behalf into your account. Your own mandatory contributions, if applicable, are withheld from your gross, or pretax, income. Voluntary contributions are withheld from your net, or after-tax, income.

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Employer Contributions and Employer Match

As noted previously, your employer must contribute to your 401(a) account. How much it contributes depends on the rules it establishes for the 401(a) plan.

In cases where the 401(a) plan allows employees to make contributions, some employers match these contributions. The match is typically a percentage of the employees’ contribution, up to a specified limit. For example, the employer might match 100% of an employee’s contributions up to 6% of the employee’s salary.

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“You always have full ownership of funds you contribute to your 401(a) account. Not so for the funds your employer contributes,” said Sternbach. Ownership of your employer’s contributions typically revert to you according to a vesting schedule — for example, 20% per year for five years, at which time you’ll be fully vested. Vested funds are yours to take should you leave your job.

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How Much Should I Contribute To My 401(a)?

“Assuming your plan allows employee contribution, it’s best to take a formulaic approach,” said George Birrell, CPA and founder of Taxhub, a personal income tax filing platform. “Generally, one must consider their current nest egg, years until retirement and risk aversion to plug into a retirement calculator to get a recommended contribution rate.”

Another approach is to follow recommendations for 401(k) plan participants and sock away at least as much as your employer’s matching contributions, Catherine Golladay, senior vice president at Schwab, said in the GOBankingRates guide to the Best Strategies To Get the Most Out of Your 401(k).

Even if you can’t take full advantage of your employer’s match, you can still maximize your contributions by saving more than your plan’s default rate and increasing your contribution incrementally each year. And sticking with your employer until you’re fully vested guarantees that you get 100% of your employer’s contributions as well as your own.

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Choosing Investments for Your 401(a)

Your employer selects which investments to offer, and these plans often have a relatively limited selection compared to 401(k) plans. Balance riskier investments like stocks with safer ones like bond funds, and weight your portfolio more heavily toward safer investments as you get closer to retirement.

A financial professional can help you build a portfolio that matches your risk tolerance and overall financial situation. In How To Find the Best Financial Advisor for You, GOBankingRates provides an overview of the various types of advisors you might work with.

Top Picks: Best Brokers of 2019-2020

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Can I Withdraw From My 401(a)?

A 401(a) is intended to help you save for retirement, so the IRS imposes strict penalties for early withdrawals — those you make before age 59 1/2, in most cases. In addition to paying personal income tax on the money you withdraw, you’ll pay a 10% penalty tax on the withdrawn funds.

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That said, there are some instances when you’re allowed to withdraw money before age 59 1/2. They include:

  • Total and permanent disability
  • Distribution via equal periodic payments over your life expectancy after you’ve stopped working for your employer
  • Leaving your employer at or after age 55 (age 50 in some cases)
  • Medical expenses exceeding 7.5% of your adjusted gross income

In the event you do need to make a withdrawal, the process is similar to withdrawing from a 401(k). GOBankingRates’ Ways To Withdraw Money From Your 401(k) Without Penalty recommends reviewing your plan contract to find out what your options are — you might be allowed to take a loan from your vested funds, for example — and then contacting your employer’s plan administrator to find out how to proceed.

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401(a) vs. 401(k): What’s the Difference?

The primary difference between a 401(a) vs. a 401(k) is that the 401(a) is for employees of governments, educational facilities and nonprofit organizations, whereas a 401(k) is for employees of private-sector companies. Although both are employer-sponsored qualified benefit plans, they differ in other important ways:

  • Participation: Whereas 401(k) participation is voluntary, 401(a) participation is usually mandatory.
  • Qualification: Employers who offer a 401(k) must offer it to all employees. Employers may and often do reserve 401(a) plans for key employees.
  • Contributions: Employees choose how much much they’ll contribute to a 401(k) plan, and their contributions come from pretax income. Employers may offer matching contributions but are not required to. With a 401(a), employers choose how much pretax income employees must contribute, and the employer must contribute on the employee’s behalf. Some plans allow the employee to make additional, voluntary after-tax contributions. Employers may match employee contributions but aren’t required to.
  • Contribution Limits: Employees may contribute up to $19,500 to their 401(k) in 2020, and those ages 50 and older can make an additional $6,500 in catch-up contributions. The combined limit for employer and employee contributions is $57,000 — plus $6,500 in catch-up contributions. Employees may contribute 100% of their salary to a 401(a) plan, but contributions from all sources are capped $57,000, and there’s no catch-up provision.
  • Investments: Employees typically have many investment options for their 401(k) contributions, and they might be able to choose from different types of 401(k) plans, such as a Roth 401(k). Investment options for 401(a) plans are usually more limited.
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Difference Between 401(a) and 401(k) Plans

Plan Type Participation All Employees Qualify? Contributions Contribution Limits Investment Choices
401(a) Mandatory No
  • Mandatory pretax contributions
  • Voluntary after-tax contributions
  • Possible employer match
  • 100% of earnings for mandatory pretax contributions
  • 25% of earnings for voluntary after-tax contributions
  • $57,000 total contributions
Limited compared with a 401(k)
401(k) Voluntary Yes
  • Voluntary contributions
  • Possible employer match
  • $19,500 in employee contributions
  • $57,000 total contributions
Larger variety of investments and possibly 401(k) plan types to choose from

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What Is the Difference Between a 401(a) and a 403(b)?

The 403(b) is typically available only to employees of public education or religious institutions, hospital co-ops and nonprofit organizations. As is the case with 401(a) plans, employers may choose who qualifies for a 403(b) and employee contributions come from pretax income.

Whereas 401(a) investment options are more restricted than 401(k) investment options, the choices for a 403(b) might be more limited still. Choices may even be confined to an annuity provided by an insurance company rather than the mutual funds available to most 401(a) investors.

The two plan types also differ in terms of contribution limits. Your 401(a) contributions combined with your employer’s mustn’t exceed $57,000 for tax year 2020. Employees with 403(b) plans have similar limits to those with 401(k) plans — a normal limit of $19,500 plus a catch-up contribution of $6,500 for employees ages 50 and older. Unlike the 401(k), the 403(b) has a lifetime catch-up contribution limit of $15,500.

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Saving For More Than Just Retirement

Saving for retirement makes good financial sense, but your 401(a) isn’t the only way to do it. And it’s smart to build separate savings for nonretirement expenses like emergency home and car repairs, children’s education and a cash reserve you can fall back on in the event you lose your job.

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The following savings and investment options can help you build wealth for retirement while you save toward other goals.

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High-Yield Savings Account

With average savings account interest hovering at 0.09%, it’s worth shopping around for a high-yield savings account that pays better rates. In fact, GOBankingRates’ guide, Are High-Yield Savings Accounts Worth It? Here’s Everything You Need To Know, lists six top banks paying higher-than-average annual percentage yields.

Although even high-yield accounts generate lower returns than products like certificates of deposit, and you’ll probably need to bank online to get the best rates, this is a safe way to sock away money for long- or short-term goals. And some banks let you open a high-yield savings account with no minimum deposit.

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Money Market Account

A money market account also pays higher interest than a standard savings account. But you’ll typically need at least $2,500 to open and maintain one, according to GOBankingRates’ What Is a Money Market Account?

On the upside, you can open a money market account locally, at a physical bank branch, and you can also get instant access to your money there. Plus, some money market accounts have perks like check-writing privileges.

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Individual Retirement Account

An IRA can be a good adjunct to your 401(a) plan.

Unlike money in a high-yield savings or money market account, IRA funds are invested, which means you can lose money if the equities you invest in decline in value. But the investment choices are vast. Not only can you reduce your risk by creating a balanced portfolio within your IRA account, but you can also use your IRA to balance the investments in your 401(a).

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IRA contributions are tax-deferred, so you don’t pay tax on the money until you withdraw it in retirement. You can contribute up to $6,000 per year in 2020 — $7,000 if you’re age 50 or older. Those limits are per person, not per account.

It’s wise to make the maximum IRA contribution if you can, according to What Is an IRA, GOBankingRates’ overview of IRAs and how they work. But note that the tax deduction starts phasing out at $65,000 adjusted gross income for single filers and heads of household and $104,000 for married taxpayers filing joint returns.

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Roth IRA

A Roth IRA differs from a traditional IRA in that you contribute after-tax income to the Roth IRA. Withdrawals you make as part of a qualified distribution, such as reaching age 59 1/2, are tax-free.

Another benefit of the Roth IRA is that it has no minimum distribution requirement as long as you’re the original owner of the account. With a traditional IRA, the clock starts ticking when you reach age 70 1/2. You’ll be forced to start taking distributions April 1 the following year, and then continue taking them by Dec. 31 in each subsequent year.

Learn More: What Is a Roth IRA?

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Your Retirement Savings Plan

It’s never too early to start preparing for retirement, and your 401(a) can play an important role in your overall strategy. Also, take advantage of any other individual and employer-sponsored retirement plans you qualify for. And don’t forget more immediate savings goals. Having money put aside for emergencies and shorter-term expenses is your bet for riding out financial challenges without having to tap into your retirement funds prematurely.

Click through to read more on the best retirement plans and their features.

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About the Author

Daria Uhlig

Daria Uhlig is a personal finance, real estate and travel writer and editor with over 25 years of editorial experience. Her work has been featured on The Motley Fool, MSN, AOL, Yahoo! Finance, CNBC and USA Today. Daria studied journalism at the County College of Morris and earned a degree in communications at Centenary University, both in New Jersey.

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