Planning for retirement can be complicated, but it’s essential to ensure financial security later in life. Retirement plans like 401(a) and 401(k) accounts are designed to help you save, but they work in different ways. The purpose of this article is to compare the differences between a 401(a) and a 401(k) plan.
Key differences between a 401(a) and 401(k) include eligibility requirements, contribution structures, and the extent of employer involvement. The best choice for you depends on your individual circumstances and, in many cases, your employment sector.
What is a 401(a) plan?
A 401(a) is a type of defined contribution retirement plan. Usually, you’ll find these plans offered by public sector employers. Think government agencies, schools, and non-profits.
One key thing to know is that employers often have to contribute to a 401(a), and the amount they put in is predetermined. You, as the employee, are often required to participate, too.
The investment choices in a 401(a) might be a bit more limited than what you’d see in a typical 401(k), so it’s worth checking out what’s available.
What is a 401(k)?
A 401(k) is a “defined contribution” retirement plan. This just means that you and/or your employer put a specific amount of money into your retirement account on a regular basis.
Private companies and corporations typically offer 401(k) plans. As an employee, participating in a 401(k) is completely up to you.
Your employer might match a percentage of your contributions, but they don’t have to. Usually, with a 401(k), you get to choose how your contributions are invested, giving you more control over your retirement savings.
Who can participate?
Eligibility and participation rules differ quite a bit between 401(a) and 401(k) plans.
401(a) Plans
If you work for a qualifying public sector organization, you’re likely eligible for the plan. In many cases, participation is mandatory as a condition of your employment. So, you may not have a choice about whether you participate.
401(k) Plans
If you work for a private sector company that offers a 401(k) plan, you’re probably eligible to participate. However, unlike 401(a) plans, participation is almost always voluntary. You get to decide whether you want to enroll and contribute.
Contribution Structure
The way contributions are structured is a key difference between 401(a) and 401(k) plans.
401(a) Plans
- Typically, employers are required to contribute to a 401(a), and the amount they contribute is determined by them.
- Employees may also be required to contribute, but the details depend on the specific plan.
- The contribution limits were significantly higher than 401(k)s, coming in at $61,000 in 2022 and $66,000 in 2023.
401(k) Plans
- Employee contributions are voluntary, up to the limits set by the IRS. You decide how much (if anything) you want to contribute.
- Employers may offer to match a percentage of your contributions as an incentive to participate. It’s basically free money!
- The contribution limits were $20,500 in 2022 and $22,500 in 2023. There’s also a “catch-up” contribution of $6,500 for those age 50 and over, letting you sock away even more.
Investment Options
How much say do you have in deciding where your retirement money is invested? Here’s how the two plans typically differ.
401(a) Plans
With a 401(a) plan, your investment options may be somewhat limited. The options are often chosen by your employer and may include a mix of bond funds, stock funds, and target-date funds.
401(k) Plans
These plans typically offer more investment choices, including individual stocks and bonds, as well as a variety of mutual funds. As an employee, you’ll likely have more control over how your investments are allocated within the plan.
Taxation and the Saver’s Credit
Both 401(a) and 401(k) plans offer tax advantages, although the specific benefits depend on whether you contribute on a pre-tax or post-tax basis.
Pre-Tax vs. Post-Tax Contributions
You can contribute to both types of plans using pre-tax or post-tax money.
If you contribute on a pre-tax basis, you’ll reduce your taxable income in the year you make the contribution. However, you’ll pay income taxes on your withdrawals in retirement.
If you contribute on a post-tax basis (Roth), you’ll pay taxes on the money now, but qualified withdrawals in retirement will be completely tax-free.
The Saver’s Credit
Depending on your income, you may also be eligible for the Saver’s Credit, a tax break for individuals who contribute to retirement plans, including 401(a)s and 401(k)s. This credit can be worth up to $1,000 for single filers and $2,000 for married couples, but eligibility hinges on your adjusted gross income (AGI) and how much you contribute.
Withdrawal Rules and Penalties
Both 401(a) and 401(k) plans follow similar withdrawal rules set by the IRS. Typically, if you take money out before you turn 59 and a half, you’ll have to pay a 10% penalty, although there are some exceptions.
You also have to start taking Required Minimum Distributions (RMDs) when you turn 73. (Check with the IRS for the most current RMD age.)
Keep in mind that specific withdrawal rules and exceptions can be different depending on the plan and your individual situation. It’s always smart to check the details of your specific plan.
Flexibility and Control
If you want to be in the driver’s seat when it comes to your retirement savings, a 401(k) might be the better option. Generally, 401(k)s offer more flexibility and control than 401(a) plans.
With a 401(k), you usually have more choices about how your money is invested, and you can customize your portfolio to fit your risk tolerance and retirement goals. On the other hand, 401(a) plans often involve investment strategies chosen by your employer, which can mean less direct control for you.
Which retirement plan is right for me?
The best plan for you depends on whether you work in the public sector or the private sector.
You should also think about your personal financial goals, how much risk you’re comfortable with, and how much control you want over your investments. It’s important to assess what your employer contributes and whether they offer matching programs.
If you have access to both a 401(a) and a 401(k), consider talking to a financial advisor to help you decide.
In Summary
The main difference between a 401(a) and a 401(k) is who contributes to the plan and how the money can be withdrawn. The best choice for you depends on your individual situation and employment. A financial advisor can help you decide which plan is right for you and your retirement goals.