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

The main distinction involves the kinds of employers who offer them.

401(a) vs. 403(k): An Overview

The two primary types of defined contribution retirement savings plans offered by employers are 401(k) and 401(a) plans. They take their names from Section 401 of the United States Internal Revenue Code, which defines them.

The principal differences between a 401(a) plan and a 401(k) plan are first in the types of employers that offer them and then in several critical provisions regarding contributions and investment choices.

Key Takeaways

  • 401(a) plans are generally offered by government and nonprofit employers, while 401(k) plans are more common in the private sector.
  • Often enrollment in a 401(a) plan is mandatory for employees.
  • Participation in a 401(k) plan is not mandatory.
  • Withdrawals from traditional 401k plans are taxed as income.
  • Employee contributions to the 401(a) plan are determined by the employer, while 401(k) participants decide how much, if anything, they wish to contribute to their plan.

401(a)

A 401(a) plan is generally offered by government agencies, educational institutions, and nonprofit organizations rather than by corporations. These plans are usually custom-designed and can be offered to key employees as an added incentive to stay with the organization. The employer usually sets the employee contribution amounts, and the employer is also required to contribute to the plan. Contributions can be either pre-or post-tax.

Because the sponsoring employer establishes the contribution and vesting schedules in a 401(a), these plans can be set up in ways that encourage employees to stay. Employee participation is often mandatory. If employees leave, they can usually withdraw their vested money by rolling it over into another qualified retirement savings plan or purchasing an annuity.

The employer determines the plan's investment choices and tends to be limited. Government-sponsored 401(a) plans, in particular, may include only the safest, most conservative investment options.

Educational institutions often offer a related plan called a 403(b) plan.

401(k)

Private-sector employers usually offer a 401(k) plan. A traditional 401(k) allows employees to contribute pre-tax dollars from their paycheck to the account and take a tax deduction for their contributions.

The employer sponsoring the 401(k) plan selects which investment options will be available to participants. However, as a function of their fiduciary duty, they need to be careful to offer a broader range of options than the sponsors of 401(a) plans often do. Plans typically offer 15 to 30 investment options, though research has indicated that too many choices confuse participants.

However, with the SECURE Act of 2019, employees may find more annuity plans offered as investment options in their 401(k) plans. The SECURE Act now protects employers from being sued should the annuity insurer fail to make annuity payments to the plan participants. Assets in a 401(k) plan accrue on a tax-deferred basis and, in the case of traditional 401(k)s, are taxed as regular income when they are withdrawn. Withdrawals from a Roth 401(k) are generally tax-free.

Roth 401(k)s, on the other hand, are funded with after-tax dollars and provide no upfront tax benefit. Employees decide how much they wish to contribute, up to limits set by the IRS, and many employers match at least a portion of their employees' contributions, although that is not legally required.

Key Differences

The main difference between a 401(k) and 401(a) plans is the type of job that they offer them, and whether or not there are contribution requirements. If you work for a nonprofit or government job, you will likely have a 401(a) plan as part of your benefits package. The government and nonprofit organizations that offer 401(a) plans make it mandatory for their employees to enroll and contribute an amount set by the employer. If you work for a for-profit company that has a 401(k) retirement plan available, you can choose whether or not you want to enroll, and you can set your contributions.

The tax rules may differ between the two plans. If you have a 401(a), your employer may structure your plan's contributions as either after-tax or pre-tax dollars. It will depend on the employer you work for because the employers, not the employees, structure the way taxes are handled with a 401(a). Pre-tax means contributions are not taxed at the time of investment but later upon withdrawal. After-tax means contributions are taxed before being deposited into the account.

A 401(k) is a tax-deferred retirement plan, and usually, your contributions come directly out of your pre-tax paycheck. You pay income taxes on your withdrawals after your retire at your ordinary tax rate.

What Happens to My 401(a) When I Quit?

There are several options for your 401(k) if you leave your job. You may be able to leave it in the account, roll it over to an IRA, or you can cash it out. If you choose to do this, you will pay a 10% penalty on the withdrawal, plus owe taxes on the funds based on your tax bracket.

Is It Better to Contribute to a 401(k) or a Roth 401(k)?

Whether one is better than the other is up to an individual's situation. The difference between a 401(k) and a Roth 401(k) is how the accounts are taxed. If you contribute to a 401(k), you benefit from not being taxed on the amount because it is pre-taxed income. If you contribute to a Roth 401(k), you pay with after-tax income, meaning you don't get the tax advantage. However, when it comes to retiring with a 401(k) account, you must pay taxes on your withdrawals, but no taxes are owed on funds coming out of a Roth 401(k) if you have the account for five years or longer.

Can You Take Money Out of a 401(a)?

Yes. You can take your money out of a 401(a) but, similar to a 401(k) if you make withdrawals before age 59½, you will have to pay a 10% penalty. In addition, any funds you remove from your 401(k) will be treated as income and you will owe both federal and state taxes on it.

Article Sources
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  1. Office of the Law Revision Counsel. "26 USC 401: Qualified Pension, Profit-Sharing, and Stock Bonus Plans."

  2. Internal Revenue Service. "Government Retirement Plans Toolkit."

  3. Internal Revenue Service. "401(k) Plan Overview."

  4. Vanguard. "How America Saves 2019," Pages 60-61.

  5. TIAA-CREF Asset Management. "The Goldilocks Plan: How Big of an Investment Menu Is Just Right?," Page 1.

  6. U.S. Congress. "Public Law No: 116-94," Division O: SECURE Act of 2019, Sec. 204.

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