Do you need a 401a or a 401k?
These are defined contribution (DC) retirement plans. Employees contribute a determined percentage of their paycheck or a standard amount put into a retirement account. They are sponsored by the employer, who may opt to match a portion of their employee’s contribution to boost their savings.
Access to these accounts is restricted as they are meant to support the contributor’s post-retirement.
Why are they called 401?
The two plans derive their name from section 401 of the United States Internal Revenue Code (IRC), which authorizes them and defines their structure and requirements.
There are notable differences between them:
- the type of employers who offer them
- differences in how they are administered
- who dictates the amount to be contributed
- types of investments that they partake
They are less common than 401(k) plans because they are a preserve of government employers, education institutions, and non-profit organizations.
They also only target key personnel whose loyalty the organizations need. Several employees will not even be aware such options exist.
Employers setting up 401(a) are mandated to make contributions to the accounts. They can also mandate the employees to contribute to the accounts and dictate how much they contribute. The employer also sets the vesting schedule, which is the duration before the account holder can access the employer’s contribution to their account.
401(a) plans are mostly not subjected to discrimination testing and are easily customized to fit the target personnel.
They are often used along with other incentives so the contributor will be persuaded to stay in the institution. The level of flexibility gives the employer an advantage when recruiting and retaining key staff.
Investment choices for 401a
The investment choices for 401(a)s are determined by the employers. Consequently, there is a tendency to opt for substantially conservative investment options, usually with lower margins. These are mostly low-risk government bonds or mutual funds.
However, due to the sizes of these institutions, they may occasionally provide access to high return counters that you would otherwise not get as an individual.
The contributor should be at least 21 years of age and have worked for the company sponsoring the 401(a) plan for two years to qualify.
These are more popular than the 401(a) plans because private-sector employers offer them, and more people work for profit-making institutions. They are also open for all employees in an organization as they are indiscriminately administered.
Employers opting for this retirement plan are tested for non-discrimination to ensure the accounts don’t favor some employees unfairly, and terms are equal for all qualified contributors.
Employees decide how much they will contribute (subject to IRS contribution limit we will see later on), which can even be nothing. The employer can match this at a rate they are comfortable with up to a certain percentage of the employee’s salary, although it is not mandatory.
This matching plan contribution is what enables the plan to entice employee participation.
Choices for a 401k
The employer will provide several investment options from which the participants can choose. Unlike the 401(a)s, the employers, in this case, have a fiduciary duty to provide more and better investment options. Employees of publicly traded companies are sometimes even offered the option to buy into their company.
Participants must have been employees of the sponsoring organization for at least a year and reached the age of 21.
A Comparison of 401(a) vs 401(k) Plans
Who Offers the Plans?
401(a) plans are mainly offered by government employers, public schools, and not-for-profit organizations. 401(k) plans, on the other hand, are sponsored by private employers.
401(a) programs are not available to all employees but are customized for key employees to encourage them to stay with their organizations. 401(k) plans are open for all employees in their institutions and provide identical limits and benefits.
To be eligible to contribute to a 401(a) retirement plan, an employee must have worked for the employer sponsoring the plan for at least two years. On the other hand, to participate in a 401(k), an employee only needs to have been with the employer for one year.
The maximum contribution an individual can make to a 401(k) account annually is $19,500 in 2021 and 2020 (subject to cost of living adjustments by the IRS). If you have reached the age of 50, you are allowed an extra retirement catch-up contribution of $6,500 for the same period, also subject to adjustments. This means the maximum individual contribution possible is $26,000.
If the employer contribution matches the employee contribution, the total amount that can be contributed annually from all combined sources is $58,000 for 2021, subject to adjustments. If we add the catch-up contribution for individuals who have reached 50 years, the maximum permissible amount comes to $64,500.
The 401(a) plan also has a combined limit for employer and employee contribution at $58,000 for 2021, subject to adjustment.
It is worth noting that you cannot contribute more than 100% of your annual taxable income. That is your maximum amount.
401(k) retirement plans provide a diverse menu of options over which the employee can choose. 401(a)s, on the other hand, mostly offer limited options which the employer has decided upon.
Diversity increases your probability for higher returns, although it might be overwhelming when faced with too many opportunities to pick from.
401(a) plans may also not require too many investment options since their participants are hand-picked. You need to analyze the specific investments before deciding which one is most beneficial.
Who Decides the Monthly Contribution?
The employer dictates how much is contributed to all 401(a) plans and schedules when they are remitted. However, the employee decides how much they will contribute to 401(k) plans and can change the amount they contribute at their discretion.
The Bottom Line on the 401s
You will hardly find an employer offering both of these retirement savings plan options due to their different audiences. However, knowing how they operate may help you decide when you are considering a transition from one employer to another, especially if you are crossing from the public to private sector or vice versa.
You will be better placed to weigh the benefits against each other.