Definition of 401(a)
A 401(a) is a type of retirement plan. While not nearly as popular as a 401(k), it can still be an incredibly useful tool in your benefits administration package.
Keep reading to learn more about the details around a 401(a) and how it’s different from a 401(k).
What is a 401(a) plan?
A 401(a) is an employer-sponsored money-purchase retirement plan. It must meet the requirements of Section 401(a) of the Internal Revenue Code—thus its name.
Not every business offers a 401(a). In fact, it’s usually offered by:
- Government agencies
- Educational institutions
Meanwhile, most private companies use a 401(k) plan.
Like its 401(k) counterpart, employers and their workers can contribute to a 401(a) plan. In addition, contributions can be pre-tax or after-tax.
How does a 401(a) plan work?
Generally, 401(a) plans are considered low-risk retirement plans. This is because many of the investments within the plan are based on government bonds or value-based stock.
Employees also have flexibility in how they choose to withdraw their funds. For example, they can:
- Roll the funds into a different retirement account
- Receive a lump sum payment
- Shift it into an annuity
However, employee enrollment in a 401(a) usually is mandatory. This is quite different than an employer-sponsored 401(k) plan, which tends to be optional. Employers also have much more control over how much an employee contributes to the plan. Employers set the match amount in a 401(a), and employees must contribute their share. In a 401(k), employees can choose not to participate.
It’s also important to note that a 401(a) plan must be uniformly distributed and not favor high-salaried employees to be considered a qualified plan. Qualified 401(a) plans must follow specific minimum requirements. These can be found in Section 410 of the IRS code:
- The plan benefits at least 70 percent of employees who are not a highly compensated employee
- The employer contributions as a percentage of a low-compensation employee should be at least, on average, 70% of the average for highly-compensated employees.
Why is 401(a) important for HR and your business?
Offering a 401(a) is a retention method for many nonprofits and government organizations. This is because many employers choose to use vesting as an incentive.
Vesting means the employer will slowly give the employees more control over the account. For example, if you have a 5-year vesting period, in the first year, the employer has total control over the employee’s retirement account. But at the end of year five, employees have complete control over their 401(a):
- How much to add to their account
- Whether they want to withdraw them
As a result, employees may choose to stay longer to ensure they get full access to their 401(a) benefits.
What is the history of 401(a)s?
Retirement plans linked to the 401 section of the IRS code first surfaced in the late 1970s and early 1980s. Many attribute the first 401(k) plan to Ted Benna in 1980. But actually, just three weeks after the Revenue Act of 1978 passed in Congress, Ethan Lipsig drafted the first 401-based savings plan for Hughes Aircraft Company.
The initial plan was the 401(k), which caught on quickly. Within a year, the IRS began allowing employees to fund their 401(k) through payroll deductions.
The 401(a) plan began shortly after the enactment of the Revenue Act of 1978.
Other terms similar to 401(a) that can assist you
- 401(k) – This employer-sponsored retirement plan is for small and enterprise companies. It allows matching contributions and optional participation. Withdrawals are taxed as income.
- 403(b) – Another employer-sponsored retirement savings option, this method is usually reserved solely for public agencies and educational institutions.
- IRA – An IRA is a retirement savings account option with tax-deferred growth. Many choose to roll their 401(a) or 401(k) funds into an IRA.
- Roth IRA – A Roth IRA account provides tax-free growth. Withdrawals are also tax-free. Like a regular IRA, employees can roll their 401(a) or 401(k) funds into a Roth account.
Summary of the definition of 401(a)
Providing a 401(a) retirement benefit as a nonprofit organization or government agency allows you to help employees save for their golden years while incentivizing retention. Mandatory contributions are set on a vesting schedule to reward long-term employees.
Similar glossary definitions you must know
- Revenue Act of 1978: Law passed and enacted on Jan. 1, 1980, redefined several pieces of the income tax code and included a brief section that established the 401(k) retirement account.
- Value-based stock: An underpriced company stock that financial analysts or investors recommend as a value based on the business attributes.
- Vesting: An individual’s ability to gain control of an asset, property, or another benefit.
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