The sooner you start saving for retirement, the more money you’ll have when you retire. If you’re organizing your retirement portfolio, you’ve probably heard of a number of different retirement plan. Two common plans both start with 401, but are designated by an A version and a K version (confusing, right?). While these plans are similar, there are some differences between 401(a) plans vs 401(k) plans that anyone saving for retirement needs to understand.
What Is a 401(a) Plan?
A 401(a) plan typically covers government workers, and school and college employees, while private employers set up 401(k) plans for their employees. Another key identifier of a 401(a) plan is the investment options offered typically are more conservative than the investment options that come with 401(k) plans. However, withdrawing from either plan is similar, with penalties for withdrawing money before age 59½.
Whether you’re 25 or 35, now’s the time to start saving for retirement. Here’s a breakdown of how a 401(a) plan vs a 401(k) plan differs.
Who Contributes to Each Plan?
Under a 401(a) plan, your employer is required to make contributions to the plan, and you can choose to contribute, too, according to the IRS .
Those contributions are either based on a percentage of income, or even a certain dollar amount. If your employer contributes a percentage of your pay, you’ll be taxed on the withdrawal of these funds after retirement, according to The Financial Buff .
Regardless of whether you contribute, if your employer offers a 401(a) plan, participation is mandatory.
Under a 401(k) plan, you voluntarily choose to contribute a percentage of your pre-tax salary. You are not required to participate in a 401(k) plan. Employers are permitted to contribute to your 401(k) plan, and many will match up to 50% of your contributions, as long as their match isn’t more than 3% of your salary.
How Much Can You Contribute?
In 2018, 401(a) contribution limits increased from $54,000 to $55,000, according to the International City/County Management Association . This includes both employer and employee contributions. However, employees with 401(a) plans can also contribute to a 403(b) plan and a 457 plan at the same time.
Meanwhile, employee contributions for 401(k) plans increased from $18,000 to $18,500 in 2018. Employees who are 50 or older may contribute up to an additional $6,000, for a total of $24,500. An employee with a 401(k) plan can also have a Roth IRA. However, there are limits on how much you can contribute to an IRA account, and if you contribute too much, you’ll be penalized with a 6% tax on the excess contributions for each year that money remains in the account.
401(a) vs 401(k) Investment Options
To minimize risk, 401(a) plans often limit investment options to the safest and most secure funds, including annuities and municipal bonds. Since these funds typically have modest returns each year, your retirement account might not grow as quickly as a 401(k) plan.
Most 401(k) plans offer a variety of investment choices ranging from low risk investments like annuities and municipal bonds, to equity funds that invest in stocks and reap higher returns.
Can You Borrow from Each Plan?
You can borrow from either plan if you have an immediate financial need, but there are some restrictions.
Your employer can limit the amount you borrow from your 401(a) plan and may even choose to not allow you to borrow money at all. Legally, you cannot borrow more than half the value of your 401(a) account or $50,000—whichever is less. Because you are borrowing money from your own account, when you pay back the loan’s interest, you are paying it to yourself.
However, the IRS requires you to pay back the entire loan within five years. If you don’t pay the loan back, the IRS will consider the loan balance to be a withdrawal and you will be required to pay tax on the remaining loan amount as well as a 10% penalty if you are under age 59½.
Borrowing from a 401(k) plan is similar. You are limited to borrowing $50,000 or half of your vested balance—whichever is less. One big difference between a 401(a) plan vs a 401(k) plan is you lose out on a tax break if you borrow from your 401(k) because you are repaying it with after-tax dollars. Because your money is taxed again when you withdraw it during retirement, you are essentially being taxed twice on that money.
When Can You Withdraw From Your Retirement Plan?
You can begin to withdraw money from your 401(a) plan without penalty when you turn 59½. If you make any withdrawals prior to 59½, you’ll need to pay a 10% early withdrawal penalty. Once you reach 70½, you are required to make withdrawals if you haven’t already started to.
With a 401(k) plan, if you retire at age 55, you can start withdrawing money without penalty. However, to take advantage of this early-access provision, you need to have kept your money in the 401(k) plan and not have rolled it into a Roth IRA account. You also need to have ended your employment no earlier than the year in which you turn 55. Otherwise the restrictions are the same as with a 401(a) plan, and you can begin to withdraw money penalty-free once you turn 59½.
What are Some Less Restrictive Options?
While 401(a) and 401(k) plans have many restrictions, there are less restrictive options that allow you to start investing early. If you’re SoFi member, you can open a Invest Account and start off with just a small contribution. Other investment accounts may require a $500 minimum to open an account. You can start a SoFi Invest® Account with as little as $100.
If you start that account before age 35, imagine how much it will grow by the time you reach retirement age. And there will be no restrictions on when you borrow from it or how much you borrow from it, and no penalties for withdrawing money before age 59½.
Choose how you want to invest.
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This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.
SoFi doesn’t provide tax or legal advice. Individual circumstances are unique. Consult with a qualified tax advisor or attorney.
Advisory services offered through SoFi Wealth, LLC, a registered investment advisor.