How Does a 401(a) Plan Work?
Do you have a 401(a) plan at work for saving for retirement? What is it, and how does it work?
401(a) plans are a type of retirement savings plan that offer tax-advantaged growth potential for those who use the plan. In this guide, we will explain how 401(a) plans work and some other essential details that are good to know.
We will also answer some typical questions about 401(a) plans that people often have. So, if you are looking to learn more about a 401(a) plan and how you might be able to take advantage of it with your employer, then read on!
What Is a 401(a) Plan?
If you are someone working for a government entity or institution of learning, your employer may offer a 401(a) retirement plan. This retirement account is similar to other workplace plans, such as a 401(k), in that it lets employees build up tax-advantaged savings and doesn’t interfere with how much money they can save at work. There are, however, some key differences worth noting.
One difference between these two retirement plans comes down to who is eligible. A 401(a) plan is commonly known as a “money purchase retirement plan.” Given their limited investment options, 401(a) plans are generally seen as less risky than most 401(k) plans.
Employers such as non-governmental organizations, government agencies, and institutions of learning offer this type of retirement savings plan to their employees. The incentive for an employee to enroll in the program is the ability to save up for retirement while employed with the company long-term.
With a 401(a) plan, employers often have greater control over the plan’s strategy. Employers with a 401(a) plan usually require that employees contribute a set amount of money each month. Employers may also choose to make extra contributions in addition to the employees’ contributions.
Finally, those contributing to a 401(a) plan aren’t allowed to participate in another 401(k) retirement savings plan offered by their employer.
How Does a 401(a) Plan Work?
401(a) plans are a great way to save for retirement, but it’s important to understand how they work before enrolling in one. A worker who is eligible for the retirement plan and covered by it is a plan participant.
Plan participants can contribute money into the 401(a) account. The employer decides how much employees can contribute and sets a vesting schedule for employee contributions.
Depending on the employer’s decision, contributions are made either on an after-tax or pre-tax basis. The plan also allows employer-matching contributions to employees’ accounts – again, at the discretion of the employer.
Employees can begin withdrawing money from their account at age 59.5, without penalty, and must start taking required minimum distributions (RMDs) in their early 70s. The starting age for their RMDs will depend on their date of birth.
This will vary from employer to employer, but generally, an employee must have been employed by the sponsoring organization for at least two years and be at least 21 years of age in order to participate in the 401(a) plan.
The employer can also choose to make the contributions and other workings of the plan mandatory or voluntary.
If you were to be laid off, any fully vested contributions would still be yours. However, any unvested employer contributions would remain with your employer.
Can You Withdraw Money from a 401(a) Plan?
Yes, you can withdraw money from a 401(a) plan. However, there are some restrictions on when and how you can do so. For example, you would incur a 10% early withdrawal penalty for taking money out before age 59.5.
As mentioned earlier, people must also start taking RMDs from their 401(a) plans when they reach their early 70s. Talk to your financial professional for when your starting age for taking RMDs is. Withdrawals from 401(a) plans are also subject to income taxes. Note that this is for 401(a) money that has been built up with pre-tax contributions.
What Are Your Options with a 401(a) Plan at Retirement?
When you retire, you have several options for what to do with your 401(a) plan. Here are some pros and cons of each option:
1. Withdraw the money in a lump sum.
- Pro: You have full control of the money and can use it however you want.
- Con: You will have to pay income taxes on your entire account balance – usually a really bad idea.
2. Roll over the money from the 401(a) plan to another qualified retirement plan.
- Pro: The money can continue to grow tax-deferred in the new plan.
- Con: You may find that you don’t like the investment options in the qualified retirement plan as much as you did in the 401(a). You will also be subject to the new plan’s features, rules, and regulations, which may be less favorable.
3. Move the money from the 401(a) plan to a traditional IRA.
- Pro: You can have more options in your IRA for your goals, such as an annuity for guaranteed income for life, or investment fund options that aren’t part of your 401(a) plan.
- Con: Again, you may also find that you don’t like your options with your IRA as much as you did the ones in your 401(a) retirement plan.
4. Convert the 401(a) plan into a Roth IRA.
- Pro: With funds having after-tax status, withdrawals from the Roth IRA will be non-taxable
- Con: You will have to pay taxes on the converted amount, so talk to your financial professional about your options.
5. Leave the money in the 401(a) plan.
- Pro: The money can continue to grow tax-deferred.
- Con: You will be subject to the 401(a) plan’s rules and regulations, which may be less favorable than other options.
As you can see, there are pros and cons to each option. It’s important to consider all of your options and choose the one that is best for you.
Will You Have Enough Income with Your 401(a) Plan?
It’s difficult to say how much income you will have in retirement because it depends on many factors, such as how much money you have saved and the performance of your retirement strategies. However, 401(a) plans can provide a good source of income in retirement.
When deciding how much income you will need in retirement, it’s important to consider any other sources of income you may have, such as Social Security or a pension, as well as your spending habits.
A few of the things you may need to keep in mind when developing your retirement budget might include:
- Housing costs
- Transportation costs
- Healthcare costs
- Food and grocery costs
- Utilities and other bills
- Discretionary spending, such as entertainment and leisure activities
If you aren’t sure how much income you will need, we go into detail about all of the things you should consider in our article, “Will You Have Enough Money to Retire?” We also discuss “What Might Spending Look Like in Retirement?” so that you can arm yourself with as much information as possible when making your retirement income and future spending decisions.
After crunching the numbers, let’s say that you see a significant gap between what you have saved, your future income, and your lifestyle expenses. Then you may want to consider adding more income sources that can help close the gap, such as annuities and other income-maximizing strategies.
Plan for a Secure Retirement
Your 401(a) plan and other strategies are important factors when planning for retirement. Speak with your financial professional to discuss your options and walk you through different scenarios to see what makes sense for you.
Be sure to communicate with your significant other or spouse about their post-retirement plans. You will want to be aligned for when you both leave the workplace, what your post-retirement vision looks like together, and other important considerations, such as filing for Social Security benefits and Medicare.
Your financial professional is there to help make your money work for you in retirement. They can answer any questions you may have and will help you prioritize your goals so that you can have peace of mind about your financial future in retirement.
Finding the Right Guide for Your Financial Goals
If you are looking for a financial professional to assist you, consider working with someone who is independent and not captive to one financial or insurance company, or a handful. For convenience’s sake, many independent and experienced financial professionals are available here at SafeMoney.com.
You can connect with someone directly by visiting our “Find a Financial Professional” section and requesting an initial meeting to discuss your situation. Feel free to ask any questions on your mind during that time, and explore a potential working relationship with that contact. If you want a personal referral, please call us at 877.476.9723.