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401(a) Plan vs. 401(k) Plan: What Is The Difference? | Full Guide


401a Plan Vs 401k Plan ConceptWhen it comes time to choose a retirement plan, the options can often be confusing. Since most retirement plans are employer-sponsored, the plans that are available to you might depend on your work situation. Many employees in the private sector have access to a 401k while those who work for educational institutions, government agencies, or non-profit organizations might have access to a 401a. But what happens when you have access to both? How do you choose the one that is right for you? Keep reading to learn more about 401a and 401k plans and the differences between the two.

What Is A 401(a) Plan?

So, what is a 401a? A 401a retirement plan is a form of defined contribution plan that allows contributions from both the employee and employer. The specific rules about these plans are laid out in Section 401(a) of the Internal Revenue Code. Typically, these plans are offered to employees of government agencies and non-profit organizations, much like a 457(b) plan or 403(b) plan. Employers have quite a bit of control over both the employee and employer contributions into the plan. The employer decides whether employee contributions are voluntary or mandatory. Employer contributions are always mandatory, although the amount of the contributions can change. Employers may decide to contribute a fixed dollar amount or a matching percentage based on the amount of contributions by the employee. Contributions may be made either pre-tax or after-tax. Employers often have strict rules around eligibility criteria, vesting schedules, and contribution amounts to encourage employees to remain in employment.

Employees may contribute up to a total of $58,000 per year into their 401a as of 2021. This includes both employee and employer contributions. There is no distinction between the two when it comes to the total contribution limits. The investment options available in a 401a are generally limited to very conservative and safe options. Mutual funds and annuities are essentially the only options available for these types of plans.

When it comes time to withdraw your funds, the withdrawal rules are fairly typical of most retirement plans. If you withdraw money before age 59 1/2, then you will incur a 10% early withdrawal penalty. If you leave your job, then you are allowed to rollover your funds into another qualified retirement plan like a 401k or IRA. You might even decide to choose a Roth IRA for the rollover.


What Is A 401(k) Plan

The 401k plan is likely the most common form of retirement savings plan out there. These plans are commonly available at most employers in the private sector and even some in the public sector. Your employer establishes specific rules regarding your plan, but the IRS does lay out the general provisions that must be followed when it comes to 401k plans. These retirement accounts allow you to make tax-deferred contributions to your plan. This reduces the amount of income tax that you will owe in the current year, and you will pay income taxes on these funds when withdrawals are made.

In any given year, you may contribute up to $19,500 into your 401k. Your employer might also decide to make matching contributions to your account. Generally, this match is a percentage of your salary up to a maximum matching amount. If you are age 50 or older, then you can contribute an additional $6,500 per year in catch up contributions. The investment choices available are typically fairly wide with a 401k. Some plans may have 20 or more investment options to choose from. These options can vary from stocks and bonds to mutual funds or other publicly traded securities.

The withdrawal rules for a 401k follow the same general guidelines as other retirement plans. Your pre-tax contributions cannot be withdrawn until age 59 1/2 without paying a penalty. In some cases, you may be able to access these funds at age 55 if you retire early. If you leave your employer, then you can perform a rollover of the funds into another qualified account like an IRA or other 401k.

401(a) VS 401(k): Key Differences

Although these two plans are quite similar, there are some important differences between the two. We will discuss those key differences here.

Contribution Rules

When it comes to contributions, your employer has much more control over those in a 401a vs 401k. With a 401a, employer contributions are mandatory, and they may require mandatory employee plan contributions as well. The contributions made by your employer into a 401a plan can be either a fixed dollar amount or a matching percentage of the employee’s contributions. 401k contributions are almost always voluntary, and employers are not required to make matching contributions although they usually do.


Contribution Limits

The limits on the amount of money you can place into these accounts is a little different. With a 401k, you can place up to $19,500 into your account. If you are over age 50, then you can place an additional $6,500 into the account. With a 401a, your voluntary contributions can be up to 25% of your salary. You can place a total of $58,000 into your account in any given year between both your employee and employer contributions.


Investment Options

A 401k usually offers a much wider range of investment choices than a 401a. The choices available in a 401a are quite limited to very safe options. This includes annuities and mutual funds. With a 401k, you can invest in stocks, bonds, mutual funds, and other ETFs. Of course, these investments can be riskier as well but may provide a higher return in some cases.

Tax Treatment

The tax treatment of these two plans is quite similar. Pre-tax contributions to the plans will give you a tax deduction in the current year. However, you will owe some tax dollars when you make withdrawals. With a Roth 401(k) or Roth 401(a), you will place your money into the account on an after-tax basis. This allows you to make withdrawals tax-free when retirement rolls around.


Plan Withdrawals

When it comes time to withdraw money from your account, these two plans function quite similarly. Withdrawals can be made penalty-free after reaching age 59 1/2. With a 401k, you might be able to access your funds without a penalty at age 55 if you retire early. If you get money out before your retirement age, then you will pay a 10% tax penalty with either plan.


Rollover Rules

When you change employers, you often have to decide what to do with the money in your retirement savings account. The rollover rules for both accounts allow you to move your money to another qualified plan like an IRA or another 401(k). You may choose either a traditional IRA or Roth account for your rollover. Most of the time, a rollover must be done on a lump sum basis meaning that the entire account must be rolled into the new account. With a 401k, you might even be able to take advantage of a mega backdoor Roth when performing your rollover.


Roth Options

Both a 401a and 401k have Roth options available. The tax benefits associated with Roth accounts are slightly different. With the Roth account, you pay income taxes in the current year, but your withdrawals are tax-free during retirement. When it comes to retirement planning, a financial advisor can help you decide whether a traditional or Roth account is right for you.


IRA Plans – How They Compare

An Individual Retirement Account (IRA) is another type of retirement plan that many people take advantage of. These plans are not employer-sponsored, and they are often used by business owners, self-employed individuals, and other individuals who do not have access to a plan through their employer. IRA’s still provide tax credits in the current year and the tax code spells out all the rules about contribution limits and withdrawals.

When it comes to an IRA, you can only contribute $6,000 per year into your account. This is much lower than most employer-sponsored plans. When it comes time to withdraw money from your IRA, you cannot do so before age 59 1/2 unless you want to pay a penalty. At retirement age, you will pay regular income taxes on the money you withdraw from your IRA. Even if you have a 401a or 401k, you can still choose to open an IRA and deposit money into that account.


The Bottom Line

Both 401a and 401k accounts are great ways to save for retirement. The plans are quite similar although there are a few important differences. When choosing between the two plans, you should consider your personal financial and employment situation. Often, your employer is the deciding factor because they may only offer one type of plan. Regardless, it is a great idea to participate in these plans if offered by your employer. Plan participants can grow their retirement savings quickly and get some great tax benefits!

Frequently Asked Questions

Is a 401a better than a 401k?

These plans are quite similar, and one is not necessarily better than the other. There are pros and cons to each, and the type of plan offered by your employer might depend on whether you work in the public or private sector. Both plans allow for tax deferred contributions which can grow tax-free until retirement.


What is the downside to a 401a?

While a 401(a) has many great advantages, there are a few downsides. Your employer has a great deal of control over your contributions and whether you are required to make mandatory contributions. In addition, your investment options with a 401a are quite limited. The only options generally available are annuities and mutual funds.


What are the benefits of a 401k plan?

A 401k plan allows you to make tax-deferred contributions that can grow tax-free until retirement age. The contribution limits are quite high so that you can grow your savings quickly. A 401k offers a wide range of investment options, so you have many choices available. Roth options also exist which allow you to make withdrawals tax-free when you begin taking money out of the account at retirement.


What are the advantages of a 401a over a 401k?

One of the biggest advantages to a 401a vs a 401k lies in the contribution limits. A 401a allows a maximum contribution of $58,000 per year into your account. There is no distinction between employer and employee contributions, so any combination of contributions can be made to arrive at this limit. With a 401k, you are only allowed to put $19,500 into your account each year.


Can you cash out a 401a?

When you leave your employer, you can cash out your account and rollover the balance into another qualified plan without a penalty. If you decide to cash it out and withdraw the money without rolling over, then you will pay a 10% penalty if you do so before age 59 1/2. Rollovers incur no penalty as long as the full account balance is rolled into another qualified plan.


What is the maximum contribution to a 401k?

The max that you can contribute to your 401k each year is $19,500. If you are over age 50, then you can make additional contributions of $6,500 to your account. The IRS allows these catch up contributions to help grow your account more quickly right before retirement age. The IRS does change these limits from time to time. They typically increase every few years to keep up with the cost of living increases.