What Is a 401(a) Plan and How It Differs From a 401(k)?

A 401(a) plan is an employer-sponsored retirement savings plan, based on Internal Revenue Code (IRC) Section 401(a). Qualified plans meet specific requirements, offering tax advantages to employers and employees. These plans encourage long-term savings by offering tax-deferred growth on investments.

Core Features of 401(a) Plans

Plans under IRC Section 401(a) are “qualified” plans. This means they adhere to Internal Revenue Service (IRS) and Employee Retirement Income Security Act (ERISA) guidelines, allowing favorable tax treatment. Employers can deduct contributions, and employee contributions and investment earnings grow tax-deferred until withdrawal.

Employers establish and maintain these plans for their employees’ benefit. Contributions primarily come from the employer, though some plans permit or require employee contributions. All contributions are subject to annual IRS limits.

Employer contributions involve vesting schedules, which determine when an employee gains full ownership of the funds. Common schedules include “cliff vesting,” where employees become 100% vested after a specific period, often three years. “Graded vesting” increases ownership gradually over several years, such as two to six years. Employee contributions are always immediately 100% vested.

Distributions from 401(a) plans typically occur upon reaching retirement age, separation from service, disability, or death. These distributions are taxed as ordinary income when received. Withdrawals made before age 59½ may be subject to a 10% additional tax, unless an IRS exception applies, such as disability or death.

Qualified plans must adhere to non-discrimination rules, ensuring benefits and contributions do not disproportionately favor highly compensated employees. These rules involve various tests, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests for plans that include employee elective deferrals or employer matching contributions.

Common Types of 401(a) Plans

The 401(a) framework encompasses various retirement plan designs, each tailored to different employer objectives. Defined Benefit Plans, for instance, promise a specific, predetermined monthly income at retirement, often calculated using an employee’s salary and years of service. In these plans, the employer bears the investment risk, ensuring the promised payout regardless of market performance.

Money Purchase Pension Plans are another type of 401(a) plan, characterized by mandatory, fixed employer contributions to each employee’s account. Employers commit to contributing a set percentage of an employee’s compensation each year, irrespective of company profitability. These plans are a type of defined contribution plan, meaning the retirement benefit depends on the contributions made and the investment performance of the individual account.

Profit-Sharing Plans, while also defined contribution plans, offer employers more flexibility with their contributions. Employers can make discretionary contributions to employee accounts, which may or may not be tied to the company’s profits. This flexibility allows employers to adjust contributions based on financial performance, and a specific allocation formula is used to distribute these contributions among eligible employees.

The 401(a) framework also includes specialized plans like 403(b) and 457(b) plans, designed for specific sectors. 403(b) plans are offered to employees of public schools, certain hospitals, and other tax-exempt organizations under IRC Section 501(c)(3). Both employer and employee contributions are permitted in these plans.

Similarly, 457(b) plans are available to employees of state and local government entities, as well as some non-governmental tax-exempt organizations. These plans provide an additional avenue for retirement savings, with rules that can complement other available retirement benefits.

Distinguishing 401(a) from 401(k) Plans

A common point of confusion arises when comparing 401(a) and 401(k) plans, as a 401(k) plan is a specific type under the broader 401(a) classification. For a 401(k) plan to offer its tax advantages, it must fulfill the general qualification requirements outlined in IRC Section 401(a).

The primary feature distinguishing a 401(k) plan is its emphasis on employee elective deferrals, allowing participants to contribute a portion of their salary on a pre-tax basis directly to their retirement account. Employers supplement these employee contributions with matching contributions, providing an additional incentive for savings.

In contrast, other 401(a) plans, such as profit-sharing or defined benefit plans, feature employer-funded contributions as their main component and may not include an employee elective deferral option. While 401(k) plans are prevalent in the private sector, many other 401(a) plans are common in governmental, educational, and non-profit organizations. Therefore, 401(a) serves as the overarching term for various qualified employer-sponsored retirement plans, with 401(k) representing a popular subset within this framework.