By Dr. Jim Dahle, WCI Founder
Many doctors and other people working for public employers have never heard of a 401(a) when they start working for their employer. The more well-known 401(k) is actually a type of 401(a). I write the letters in parentheses because it's actually referred to in section 401 of the IRS code under subsections (a) and (k). Other retirement plans like 403(b)s and 457(b)s are similar.
In actual practice, however, most people consider 401(a)s and 401(k)s to be two different beasts.
Here's what you should know about 401(a)s.
401(a)s Are Mostly for Government Employees
401(a)s are generally offered to government employees. In the case of one of my siblings, it was to replace a previous true defined benefit pension plan. The municipality he works for decided to have the employees run the investment risk instead of the municipality taking that risk, so he gets a 401(a) instead of a pension. The municipality still puts a significant sum into the account each year, so in many respects, it's still quite a good retirement plan. It was interesting to see how the paperwork described the contributions to the plan. The plan required the employee to make a mandatory contribution of 8% of his salary, and then the employer matched it with 5% of his salary. In addition, it claims that it is also putting another 17% of his salary into a fund to pay for his retirement health plan, health reimbursement account, death and disability, and “unfunded future liability.” OK, whatever.
There are no voluntary contributions into his particular retirement 401(a) account (although there is a 401(k) and a 457 as well), so it's all employer money (plus the mandatory employee contribution, which is essentially the same thing).
Many doctors, including those working at a local university, are offered a hodgepodge of retirement accounts, including a 403(b), a 457(b), and a 401(a).
More information here:
Comparing 14 Types of Retirement Accounts
ERISA Doesn't Apply to a 401(a)
The setups above are fairly typical for a 401(a). A 401(a) isn't generally covered by Title I of ERISA, so the employer gets to make the rules. Remember that the point of ERISA is to protect the participant. It covers things like vesting rules, fiduciary actions (like choice of investments), and disclosures. Instead, 401(a)s are regulated by state law, which is usually not as strict. You can assume it will take longer to vest in your benefits (five years, in my family member's case), the investments won't be as good (read higher expense ratios), and they won't tell you what the fees are (I couldn't find them for his plan anywhere on the web).
4 Different Types of 401(a)s
401(a)s can have significant variation. Four types are commonly seen.
401(a) Type 1
In this 401(a), the employee does nothing, and the employer makes all of the contributions. Think of it as a pension, but the employee is running the investment risk.
401(a) Type 2
In this type, all employees contribute a set percentage of their pay. Think of it as your salary being permanently lowered in order to fund the 401(a).
401(a) Type 3
Unlike the first two types, the employee actually gets a choice in this type of 401(a), although this irrevocable decision must be made when the employee first becomes eligible for the plan. You can choose not to participate at all, to participate with a low percentage of your pay, or to participate with a relatively high percentage of your pay. But whatever you choose, you're stuck with it as long as you work there. Choose carefully, my friends! It's kind of unfortunate because most people can save more in later years once they've beefed up emergency funds, paid off student loans, gotten into their dream home, etc. But in this case, you're probably best putting in the maximum and delaying some of your other financial goals if necessary.
401(a) Type 4
A less common option is a 401(a) plan that allows after-tax employee contributions. The nice thing about this type of plan is that you can change your contributions from time to time in whatever way you want. The downside is that the money is after-tax. It's neither tax-deferred nor Roth. There's no tax deduction for you like with a tax-deferred account. No tax-free earnings like with a Roth account. You often can (and should) do a Roth conversion with the money. In this respect, it's a lot like Mega Backdoor Roth IRA contributions into a 401(k).
More information here:
Financial Waterfalls for New Residents and Attendings
401(a) Contribution Limits
When talking about employer-provided retirement accounts, there are two contribution limits to think about. The first is the “employee deferral contribution limit,” sometimes called the 402(g) limit. This is the amount an employee can put into a 401(k) as a tax-deferred or Roth contribution. An employee shares this limit across all employers and retirement plans for which they are eligible. For 2023, the limit is $22,500 for someone under 50 ($30,000 if 50+). Contributions to 401(a) accounts, like contributions to 457(b) accounts, do not count toward this limit at all.
The second limit is the “total contribution limit,” aka the 415(c) limit. This is the total of all employee contributions (whether tax-deferred, Roth, or after-tax) and employer contributions (whether match, profit-sharing, or penalty). This limit is not shared across plans offered by unrelated employers. That's why many doctors can use multiple 401(k)s. All 401(a) contributions count toward this limit. For 2023, this limit is $66,000 for someone under 50 ($73,500 if 50+). 457(b) contributions do not count toward this limit either.
Interestingly, if your employer offers a 401(k) and a 401(a), the two accounts share this same limit. If your employer offers a 403(b) and a 401(a), the two accounts EACH have a separate $66,000 limit. Quirky, but I don't write the rules.
Contributions Are Usually Not Optional
Mandatory contributions are not necessarily a bad thing. Frankly, I think this is probably a good idea since most people don't save if they're not forced to, but it does limit your financial flexibility. The good news is my sibling belatedly realized he actually has been saving more than 15% of his income toward retirement without even realizing it. Between his 8% mandatory employee 401(a) contribution, the 5% employer 401(a) match, the 2% 401(k) match, and his own voluntary 401(k) contributions, he was actually saving quite well for retirement.
You Get Control
Unlike a pension or defined benefit plan, you get to control the investments in a 401(a), just like a 401(k), 403(b), or 457(b). You can choose the lower-cost index funds in the plan and work around any plan limitations using other available retirement accounts, such as Backdoor Roth IRAs.
More information here:
10 Reasons I Invest in Index Funds
Beware the Fees on 401(a)s
Now, the bad news. My sibling was surprised to learn he had an investment advisor he was paying. His fees for the last quarter were $60 (50 basis points). That's not too bad . . . except it seems like all the advisor had done was pick a few funds in the plan and put the money into them. Even that is probably worth the $60, except the asset allocation made no sense at all. The two biggest components were a Russell 3000 Fund and an S&P 500 fund, which have a correlation of approximately 0.99 between them. The remaining funds were a hodgepodge of actively managed funds.
He was surprised to learn his asset allocation was 95% stock, which worked out pretty well since the years he had been working for the employer and investing (without his knowledge that he was investing) were during a pretty good bull market. In a few minutes, I made him $240 a year by firing his advisor and putting him into a reasonable asset allocation of funds. I told him $240 is better than a kick in the teeth, but it was nothing like the $15,000 a year I saved my parents by helping them see that their advisor and his fees were having a rather negative effect on their retirement investments.
More good news for my sibling was that it turned out somebody at his HR department seems to have their head screwed on right since the actual plan fees (in addition to the ERs) are just 11 basis points, plus $35 a year. Almost all of his expense ratios were under 0.20% a year, with the exception of the small cap fund, an actively managed international fund, and a socially responsible fund. But even those were under 0.75% a year. It's not quite the Federal TSP, but it beats the pants off 99% of the 401(k)s out there.
What Should You Do with Your 401(a)?
As a general rule, these are great retirement accounts, and you should max them out. Choose low-cost investments in them in accordance with your overall written investment plan. If you have the first or second type of plan, you don't have to do anything as far as deciding how much to contribute; your employer has already made that decision for you. If you have the third type, choose to max it out as that will be your last opportunity. If you have the fourth type and have already maxed out your other retirement accounts, max it out, too, and do a Mega Backdoor Roth IRA conversion with it.
If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
Do you have a 401(a)? Which type? How is it? Are you happy with the way your 401(a) has performed? Comment below!
[This updated post was originally published in 2013.]
Hi Dr. Dahle
I just graduated fellowship from University of California. Like the above post, we have the mandatory 401 (a) pre-tax at 7.5% salary contribution. I have about 22k in the 401a which everything is invested in Fidelity 2055 Target date index fund, which i think is a good fund itself.
Would you recommend doing a roth conversion into my personal roth IRA this year?Or should I just leave the fund with UC as the fund is good enough and they are a stable institution? Thank you very much!
Not enough info to answer that question. It is, after all, the most complicated question in personal finance. More info here: https://www.whitecoatinvestor.com/roth-contribution-or-conversion/
I have available to me from my employer a 403(b), a 401(a), and a subset of the 401(a) that is a 401(h). The 403b is fairly simple–allows either pre-tax or Roth contributions; the 401(a) has a couple of complexities to it that I wanted to ask about–
1. It limits highly compensated employees (>$125k/year) to a 3% contribution; it’s a voluntary contribution, but it’s the mechanism by which I get my match from my employer, so definitely doing it.
2. It allows the employee (my) contributions to be rolled over to a Roth IRA (so I think a Mega Backdoor Roth IRA), which is great (I think) since I’ve been rolling my contributions over to Roth IRA so now they can grow tax free.
3. It allows 25% of the employee contribution (so 25% of the 3% contribution) to be directed to a 401(h), which can be used for healthcare expenses in retirement tax-free.
4. Disbursement options for the 401(a) upon retirement are either the default, which is the purchase of an annuity, lump sum payment, or installment payments.
Here’s what the plan says about the annuity–
“The normal form of payment under this Plan is an annuity. This means that your vested Account balance as of your annuity starting date (except any amounts allocated to your Retiree Health Insurance Savings Account) will be used to purchase a life annuity contract with a modified cash refund (a guarantee upon death of a return of employee contributions with credited interest up to retirement) from an insurance company if you are single, or a qualified joint and survivor annuity if you are married. The annuity starting date is the date that is ninety days prior to the initial annuity payment. The insurance company will make monthly payments to you for your life based upon the type of annuity purchased.”
So with all that, my 401(a) seems kind of unique; couldn’t find answers to these questions elsewhere, so my questions here are–
1. Upon disbursement with the lump sum and installment payment options, I would be getting taxed on the employer contribution portion/growth, so it seems to make sense to reduce the tax burden, I should be taking the 25% 401(h) option, and also periodically rolling over my contributions to the Roth IRA to ensure tax free growth, right?
2. But I’m not sure really how to take into account the default annuity option in my retirement planning…I looked at the plan literature and it just said that the funds would be utilized to purchase an annuity, but not sure how to crunch the numbers on that. Any suggestions here?
Are you sure you can’t just roll the 401(a) into an IRA when you leave the employer? Seems odd not to have that option.
Whether or not to do the Roth conversions as you go along is a VERY complicated question. More info here:
https://www.whitecoatinvestor.com/roth-contribution-or-conversion/
401(h) money, so long as it is actually spent on health care, is a particularly tax efficient way to use your 401(a) money. More info here:
https://www.whitecoatinvestor.com/401h-plans-the-qualified-plan-tax-free-triple-play/
So if 25% of your 401(a) money is an amount reasonable to spend on health care in your life time, then sure, max out the 401(h).
Hmm, the 401(a) only permits after tax (not Roth) contributions. The verbiage that the 401(h) money can be withdrawn without paying taxes on it makes it seem like regular 401(a) money would be taxed on the way out too.
The Roth conversions seem to be a no brainer because it goes from post-tax for which the lifetime of growth would be taxable on the way out (if leaving in 401(a) for the lifetime) to then basically becoming Roth IRA money at no cost. It’s not the way traditionally think of a “Roth conversion” which is converting pre tax money to Roth and then paying the tax bill on it; this is just making post tax money Roth money. I just need to fill out a rollover form which I’ve done the past few years and Fidelity’s said is the smart thing to do.
My question was more to do with retirement planning—I’m doing these annual rollovers of my contributions to my 401(a) to my Roth IRA, but employer contributions can’t be rolled over. So those employer contributions will still stay in the 401(a) until retirement or until I leave this institution.
Have you seen 401(a)s with a default disbursement option of annuity? Not sure how to take that into account in my retirement planning. Or I could just take the lump sum/periodic distribution option which numerically makes planning a bit easier.
Also, thanks for the reply! Long time follower and huge fan—an immense debt of gratitude to you for helping me get my financial life in order!!
It’s really weird for a 401(a) to not be a tax-deferred account. Are you sure you have your details right? But if you’re right, then yes, the Roth conversion is a no brainer.
I don’t look at a lot of 401(a)s. I haven’t even really looked at yours. I suspect many offer an annuity distribution option. They’re pretty common in all kinds of plans.
Yep, just double checked–both my Fidelity Netbenefits as well as the plan literature; only after-tax contributions are permitted (3% max for highly compensated employees). Agreed, it’s kind of an odd one! Also odd because it’s taxable on the way out “you will pay income tax on the amount of the taxable portion of any distribution you receive from your Retirement account.”
I guess the decision on whether to take the default distribution of the plan upon retirement as an annuity vs lump sum vs installment distributions is a personal one that depends on the outlook of the rest of my portfolio at retirement, is that right? The annuity they describe is a “life annuity contract with a modified cash refund (a guarantee upon death of a return of employee contributions with credited interest up to retirement) from an insurance company if you are single, or a qualified joint and survivor annuity if you are married.” Are these the single premium immediate annuity that you describe as the most “acceptable” form of annuities?
Thanks again for your responses (and also everything that you do!!)
I guess the question is can you take a lump sum and buy a better annuity? If so, then take the lump sum. If not, and assuming you want an annuity, then take their annuity.
There are variations even on SPIAS, such as the “modified cash refund” you mention. Those all cost money in the form of a lower yield. A “pure” SPIA is swapping a lump sum for a lifelong monthly benefit, whether you die next month or in 30 years.