401(a) vs. 401(k) plans: What’s the difference?

To round out retirement benefits programs, it can be helpful for employers to know about the various types of accounts available. Section 401 of the U.S. Internal Revenue Code outlines the requirements for qualified retirement plans offered by employers, including 401(a) and 401(k) plans. 

There are a few differences between 401(a) and 401(k) plans. The most important of these are what type of employer can offer the plans, whether or not employee enrollment and employer contributions are mandatory, and the range of investment options available. Read on to learn more about these differences.

Overview of 401(k) plans

401(k) retirement plans may be offered by most private-sector employers. While these plans do not mandate employee enrollment, employers can choose to have employees opt-out, rather than opt-in, to the plan. Employees can begin contributing to their accounts after they meet the plan’s eligibility requirements. The maximum permissible eligibility requirement for a 401(k) plan is one year of service.

Likewise, employers are not required to contribute to their employees’ 401(k) plans but do have that option. Many private sector employers do contribute to the 401(k) plans they sponsor as a way of increasing recruitment and retention. Whether or not they contribute to their employees’ accounts, employers who offer a 401(k) do have a fiduciary duty to their employees to offer a diverse selection of investment options.

Tax advantages of 401(k) plans

Employers can take advantage of tax incentives related to 401(k) plans. They may deduct 100% of employee deferrals on their federal income tax return. They can also deduct up to 25% of the compensation earned during the year from eligible employees participating in the plan, if they provide the amount as an employer contribution to the plan. Legislation also provides tax incentives for qualified small businesses to start a retirement plan and additional tax incentives if they add specific provisions (i.e. automatic enrollment and employer matching) to their plan. 

For small businesses with up to 50 employees, SECURE Act 2.0 provides tax credits to cover 100% of the start-up costs of a 401(k), capped annually at $5,000 per employer for each of the first three years. Employers are also eligible for a tax credit of $500 per year for the first three years of electing auto-enrollment. Finally, small businesses with up to 50 employees may receive a tax credit based on a percentage of employer contributions (up to $1,000 per employee for employees making less than $100,000 in the prior year).

401(k) plans also provide tax advantages for employees. By contributing to a 401(k) using pre-tax dollars from their paycheck, employees’ taxable income for the current tax year may decrease. And as a long-term advantage, employees may end up paying less tax during retirement.

Overview of 401(a) plans

401(a) plans are employer-sponsored retirement accounts that can help their employees save for retirement. 401(a) plans, however, can only be offered by government, educational, and nonprofit employers, not private sector employers. (Nonprofits may also offer their employees 403(b) retirement accounts.) 

Employers sponsoring a 401(a) plan are mandated by the IRS to contribute to their employees’ plans. Employee contributions may be optional, mandatory, or not permitted at all, depending on how the employer chooses to set up the plan. Employers also choose whether the contributions are pre- or after-tax. Eligibility for participation can be up to two years of service and if the employee opts out of participation, that opt out can be considered permanent. 

There's no direct tax benefit for an employer sponsoring a 401(a) plan since entities qualified to sponsor these plans don’t file a corporate tax return. However, they are still an important part of the employer’s overall compensation and benefit package and may be a useful employee retention tool.

Key differences between 401(a) and 401(k) plans

401(a) and 401(k) plans are similar vehicles for helping employees save for retirement, but they have some important differences. The main difference is who can offer each type of plan. The other differences between the two stem from how much control employers offering 401(a) plans have over the design of the plan. In short, 401(a) plans can be offered by government, educational, and nonprofit organizations, and they offer employers more customization options than 401(k)s. 

Employers offering 401(a) plans must contribute to their employees’ retirement plans, unlike private-sector employers offering 401(k)s. Government entities and nonprofits offering 401(a) plans mandate enrollment in the plans and all employers offering 401(a) plans determine their employees’ contribution rate. Private sector employees whose employers offer a 401(k) have more flexibility and can opt in or out of the plan and determine their own contribution rate.

Ultimately, it's important to understand the differences between retirement plan types. It’s essential to know what’s available to your business and understand the requirements and limitations that come with 401(a) or 401(k) plans.