A 401(a) retirement plan is an alternative retirement plan available to government workers, educational institutions, and non-profit organizations. A 401(a) plan is similar to a 401(k) plan with a few unique differences. In this post, we will explore what a 401(a) plan is, and the important caveats you should be aware of if your employer offers it to you.
- A 401(a) plan is available for government workers, educational institutions, and non-profit organizations
- Mandatory employee contributions made to a 401(a) plan are on a pre-tax basis
- Voluntary elective employee contributions are made on an after-tax basis
- 401(a) plans have the highest contribution limits out of any other retirement plan
What is a 401(a) Plan?
A 401(a) is a “defined contribution” retirement plan sponsored by the employer that allows contributions to be made by both the employer and the plan participant. This plan allows the employee and employer to make after-tax contributions on a percentage or dollar basis.
The employer sets the plan eligibility, matching contributions, and the vesting schedule. Although similar to a 401(k) plan, a 401(a) plan has some unique characteristics. With a 401(a) plan, the employer has more direct control over managing the plan and establishing the rules. They can be designed in a way to incentivize specific employees at the organization to retain them.
The same can’t be done with a standard 401(k) plan. In addition to this, the employer has more of a say in the type of investment options that are available under the 401(a) plan. Generally, 401(a) plans are used amongst non-profit organizations, whereas 401(k) plans are more often used by for-profit organizations.
Important Note: Employers can create multiple 401(a) plans and designate them to specific employees, departments, and teams. Each plan can have its unique incentives and rules in place. They are fully managed by the employer.
401(a) Contribution Options
There are essentially four different contribution sources and options available under a 401(a) plan. They include:
- Employer Fixed Contributions – As the name implies, an employer can contribute a fixed dollar amount or percentage amount to the employee’s plan.
- Mandatory Employee Contributions – A 401(a) plan may have mandatory employee contributions for the employee to be eligible for the plan.
- Employer Matching Contributions – The employer can match a fixed percentage amount of the employee contributions. For example, if an employee contributes 5% of their base salary to their 401(a) plan, the employer can choose to match that contribution.
- Voluntary Elective Employee Contribution – Certain 401(a) plans may permit employees to make voluntary elective contributions. These can be on a dollar basis or a percentage of your yearly salary.
401(a) Max Contributions 2022
A major benefit to 401(a) plans compared to other retirement plans like 401(k), 457, 403(b) and an IRA is the high maximum contribution limit. The total contribution limit for a 401(a) defined contribution in 2022 has gone up from $58,000 to $61,000. This sum includes both employer contributions and employee contributions.
This is a very high limit compared to other retirement plans. See the different contribution limits for other retirement plans below.
More info on retirement plan limits from the IRS.
401(a) Contributions and Tax Treatment
The tax treatment of a 401(a) plan depends on whether your contributions are mandatory or voluntary. This will depend on how your employer set up and manages the plan. Your plan can have elements of mandatory contributions and voluntary contributions.
Mandatory Employee Contributions
Mandatory employee contributions may be required by your employer if you want to be eligible for an employer match. If your 401(a) plan has mandatory employee contributions, they will be on a pre-tax basis. This means that contributions made to your 401(a) plan will reduce your taxable income.
For example, let’s assume you make $100,000 per year and your employer has a mandatory 5% employee contribution in a place. This would bring down your taxable income to $95,000 instead of the original $100,000.
It’s worth noting that the earnings of a 401(a) plan grow tax-deferred. This means that you won’t pay taxes on your gains until you start taking distributions.
Voluntary Employee Elective Contributions
Voluntary employee elective contributions are made on an after-tax basis and do not reduce your taxable income. In addition, they are capped at 25% of your total yearly compensation. This is an important rule to be aware of when it comes to 401(a) contributions.
As previously mentioned, 401(a) plans are available for individuals working in government agencies, educational institutions, non-profit organizations, and charities. Below are the different employees for which this type of plan may be available.
- Police officers
- Doctors, nurses, and administrators that work for non-profit hospitals
- Pastors and ministry workers
- Social workers
- Government therapists
- Government accountants
These are just a few of the different professions for which 401(a) plans may be available. In addition to a 401(a) plan, the employer may have an option for a 403(b) plan for their employees.
How to Report a 401(a) on W2?
Reporting your contributions on your W2 is handled by your employer. They are legally required to report your wages and the taxes withheld on the earnings each year. In addition to this, your employer will report your 401(a) contributions on your W2 regardless if they were mandatory or voluntary.
We advise that you check and make sure that your employer is accurately recording your contributions on your W2. This information must be sent to the IRS so they know that you are participating in a retirement plan. This can help you save money on your tax liability
401(a) Vesting Schedule Options
The vesting schedule for a 401(a) plan will depend entirely on how the employer decides to set it up. Vesting simply means that you have to work for x amount of years for your employer before you can get ownership of your employer’s contributions to your 401(a) plan. Any contributions made directly by you to your plan are immediately vested. Employers can choose between two separate vesting schedules – graded vesting and cliff vesting.
With the graded vesting schedule option, employees gradually gain their employer’s contributions each year of continued employment. A standard graded vesting schedule is five years. Employees become vested 20% of their employer contributions each year of service until full vesting occurs. Employers that offer graded vesting do it with the intent to retain employees longer.
With cliff vesting, employees receive full benefits from the employer’s contributions at a specified date or immediately. This is common with companies who want to immediately attract talented employees. Employees receive benefits immediately and it acts as an incentive to pull them into a company.
401(a) Withdrawal Rules
401(a) plan participants can withdraw funds from the account when they reach the qualified retirement age, leave their job, or take out a loan from the plan. Fully vested amounts belong to the plan participant. Below are some of the rules and options when it comes to withdrawals.
- If the plan participant dies, the account will be passed onto their designated beneficiaries
- Withdrawals before age 59% are subject to 10% early withdrawal penalty
- Required minimum distributions are when the plan participant reaches the age 72
- The plan participant can roll the funds into an alternative retirement plan if they leave the employer
- Taxes are only paid on withdrawn funds. The amount that remains in the account continues to grow tax-deferred
Benefits of a 401(a) Retirement Plan
Below are some of the benefits of having a 401(a) plan.
- Higher maximum contribution limits than other retirement plans
- Your distribution may be tax-exempt depending on mandatory or voluntary contributions
- Earnings grow tax-deferred
- You can reduce your income taxes while saving for retirement
- Ability to roll the plan over into an alternative retirement if you leave your job
Difference Between a 401(a) and a 401(k)
The main difference between a 401(a) and a 401(k) plan comes down to the employer type. A 401(a) plan is for non-profit employers such as government agencies, educational institutions, charitable organizations, and non-profit hospitals. Contributions to a 401(a) plan are made on an after-tax basis and don’t reduce your taxable income.
On the contrary, a 401(k) plan is available to for-profit organizations. Contributions to a 401(k) are on a pre-tax basis which can reduce your taxable income. In most cases, there are more investment options available under 401(k) plans.
Understanding your options and the different ways your employer can set up a 401(a) plan can help you make the most out of your retirement. It’s worth reviewing the terms and conditions of your 401(a) plan to get a better idea of how it’s managed by your employer.
What Happens To My 401(a) Plan When I Quit or Leave Job?
You keep the plan and the amounts that fully vest. In addition to this, you can roll your plan over to a different retirement plan offered by your new employer.