What Is a 401(a)?
A 401(a) plan is an employer-sponsored retirement savings plan that is closely similar to a 401(k) plan.
A key difference is that 401(k) plans are sponsored by private institutions, while 401(a) plans are sponsored by state and local governments and some nonprofit organizations.
As a business owner, you may find that a sustainable 401(k) plan is a better fit than a 401(a) or 403(b) plan.
How Does a 401(a) Plan Work?
Below are some of the major factors involved in how a 401(a) plan works:
Tax Advantages
The tax advantages of a 401(a) plan are similar to those of a 401(k) plan.
Contributions are made pre-tax, meaning they are deducted from your pay before taxes are withheld. This reduces your annual taxable income, resulting in lower taxes owed.
Earnings in the account grow tax-deferred, meaning you will not owe taxes on them until withdrawals are made in retirement.
If funds are withdrawn before age 59.5, a 10% tax penalty will be assessed in addition to regular income taxes owed.
Contribution Limits
The contribution limit for 401(a) plans for 2023 is $66,000 ($61,000 in 2022). This amount comprises both employee and employer contributions.
Even with this limit, the IRS will only allow total contributions up to the total amount of an employee’s salary.
For instance, if an employee’s salary is $40,000 per year, the most that could be contributed to the 401(a) plan would be $40,000 in total (including employer contributions).
What Is a 403(b)?
A 403(b) is a tax-advantaged retirement savings plan offered by certain nonprofits and public school systems.
These institutions could include public schools, cooperative hospital organizations, religious organizations, and 501(c)(3) tax-exempt organizations.
How Does a 403(b) Plan Work?
Below are some of the major factors involved in how a 401(a) plan works:
Tax Advantages
Like a 401(k), contributions to a 403(b) are made pre-tax, reducing your taxable income for the year. Earnings in the account grow tax-deferred, meaning you will not owe taxes on them until withdrawals are made in retirement.
Funds should be withdrawn on or after age 59.5 to avoid the 10% tax penalty plus regular income taxes.
Contribution Limits
The 2023 contribution limit for 403(b) elective deferrals is $22,500, which is an increase from the 2022 limit of $20,500. Elective deferral means the amount an employee can withhold from his or her paycheck to contribute to the 403(b).
The total contribution limit for 403(b) plans for 2023 is $66,000 ($61,000 in 2022). Thus, if an employer decides to contribute to the employee's account, the employer can contribute up to an extra $43,500 ($66,000-$22,500) for 2023.
In 2023, a catch-up contribution of $7,500 is allowed for employees aged 50 and above who have capped out the elective deferral limit. This is an increase from 2022’s limit of $6,500.
Like the IRS's guideline for the 401(a) plan, an employee who makes less than the contribution limit will only be allowed to contribute up to his or her total annual compensation.
A 403(b) plan also allows for a special catch-up contribution called the 15-year catch-up rule.
This means that employees who have worked for their institutions for at least 15 years can contribute an additional $3,000 to their 403(b) accounts with a $15,000 cap for a lifetime.
This means that if an employee is at least 50 years old, he or she can take advantage of both the regular and special catch-up contribution limits.
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Final Thoughts
The 401(a) and 403(b) are both employer-sponsored retirement savings plans that offer tax advantages to employees.
The main difference between the two is that 401(a) plans are sponsored by state and local governments and some nonprofit organizations, while 403(b) plans are sponsored by certain nonprofits and public school systems.
Employees who participate in either plan can enjoy pretax contributions, tax-deferred growth on earnings, and potentially lower taxes in retirement.
However, it is important to note that early withdrawals from these accounts may be subject to a 10% tax penalty.
When choosing between a 401(a) and 403(b) plan, it is important to consider the contribution limits, employer match opportunities, and investment options each plan offers.
FAQs
1. What is the difference between a 401(a) and a 403(b)?
The main difference between the two is that 401(a) plans are sponsored by state and local governments and some nonprofit organizations, while 403(b) plans are sponsored by certain nonprofits and public school systems. The two also differ in terms of contribution limits and employer match limits.
2. What happens if I withdraw money from my 401(a) or 403(b) account before I turn 59.5?
Withdrawals made before age 59.5 may be subject to a 10% tax penalty plus regular income taxes.
3. What are 501(c)(3) organizations?
501(c)(3) organizations are tax-exempt organizations that are organized and operated for charitable, religious, or educational purposes. Examples include charities, churches, and schools.
4. What is the purpose of catch-up contributions?
Catch-up contributions are designed to help employees who are behind on their retirement savings to catch up by allowing them to contribute more money to their accounts. Employees who are age 50 or older are typically eligible for catch-up contributions.
5. What are the similarities between a 401(a) and a 403(b)?
Both plans offer pretax contributions, tax-deferred growth on earnings, and potentially lower taxes in retirement.
