401(a) Plan

What Is a 401(a) Plan?

A 401(a) plan is an employer-sponsored qualified retirement plan that takes its name from section 401(a) of the U.S. Internal Revenue Code, which sets out the requirements a plan must meet to receive favorable tax treatment. The plan is held in a trust and operated under written plan documents. Employers often use 401(a) plans in the public sector, at nonprofit organizations, and at some private companies. Because the plan follows federal rules, contributions and investment earnings can grow on a tax-deferred basis until money is withdrawn.

How a 401(a) Plan Works

The employer decides how the plan is designed. Many 401(a) plans are defined contribution plans, meaning each participant has an individual account, and the final balance depends on contributions and investment results. Others are defined benefit plans, which promise a specified retirement benefit based on factors such as salary and years of service. Contributions may come only from the employer, or the plan may also accept employee contributions, depending on its terms.

Common features include:

• Employer contributions set by a plan formula or by the employer's decision
• A vesting schedule that determines when employees fully own employer contributions
• Restrictions on when money can be withdrawn
• Distributions taxed as ordinary income when received

An Example and Key Rules

Suppose an employer contributes to each employee's account under a vesting schedule that grants ownership gradually over several years. An employee who leaves before becoming fully vested may keep only the vested portion of the employer's contributions, and the rest is forfeited. Withdrawals taken before the age set by federal law generally trigger an early withdrawal penalty in addition to income tax, although several exceptions apply. Once participants reach the age set by federal law, they must begin taking required minimum distributions.

Advantages and Disadvantages

Potential advantages include tax-deferred growth, funding that comes from the employer rather than from employee paychecks, and flexibility in plan design. Potential disadvantages include limited investment choices in some plans, vesting rules that can lead to forfeited contributions, restrictions on access to funds, and the fact that employees generally have little control over plan rules.

A 401(k) plan is a related arrangement that is built around employee salary deferrals. Plans of that type are generally treated as meeting the same section 401(a) requirements, so the two are often compared when investors review workplace retirement options.