403(b) plans and 401(a) plans are both employer-sponsored retirement plans available only to employees of certain organizations. They are similar in several ways, but they also have some important differences in terms of contribution limits, employer matching, and who makes decisions about the plan.
Your employer will dictate which type of plan is available to you, but it doesn't hurt to understand how both options work. Here's a brief overview of 401(a) and 403(b) plans.
A 401(a) plan, also known as a money purchase plan, is a retirement plan available to government and nonprofit employees. It gives the employer more control over the plan than you usually see with a 403(b). Your employer decides who can participate in the 401(a), and they decide whether employees may make voluntary contributions to the account or whether contributions are mandatory. If they are mandatory, the employer will also decide how much they are and whether they're a set dollar amount or a percentage of each paycheck.
Employers are also responsible for deciding what employees can invest in. These plans are usually limited to the safest types of investments, like government bonds and mutual funds that focus on value-based stocks.
The government requires employers to contribute to 401(a) accounts, even if employees do not. But the amount they contribute may vary depending on the matching system the company uses.
Employee-contributed funds immediately vest, even if the contributions were mandatory. Employer-contributed funds may be subject to a vesting schedule, which the employer determines.
Tax benefits of a 401(a) plan
A 401(a) plan may contain pre-tax or after-tax dollars. It's up to the employer to decide which one to use. Tax-deferred 401(a) contributions reduce your taxable income for the year, but you must pay taxes on withdrawals from these accounts. Contributions to after-tax 401(a)s don't reduce your taxable income, but your money grows tax-free afterward.
You typically can't withdraw funds from your 401(a) before you turn 59 1/2. Doing so results in a 10% early-withdrawal penalty, on top of any applicable taxes. You may receive distributions as a lump sum or an annuity, or you can roll them over into another retirement plan.
401(a) contribution limits
You may contribute up to $57,000 to a 401(a) in 2020. It is worth noting, however, that this $57,000 limit includes all contributions to employer-sponsored retirement accounts like 401(k)s. Voluntary employee contributions are often capped at 25% of your pay.
A 403(b) plan is available to public school employees, certain ministers, and nonprofit employees. Employers provide a range of investment options, just as with 401(a)s and 401(k)s, but contributions to 403(b)s are not mandatory. Employees may choose how much they'd like to contribute, including nothing at all.
Employers may match some of their employees' contributions, but this is not required by law and it's pretty rare. If a company does offer 403(b) matching contributions, the vesting period is usually short and some may even offer immediate vesting.
In the past, 403(b)s offered only annuities. This is no longer the case, and many now offer mutual funds, too. But if your plan offers only annuities, this could make it more expensive than other types of retirement plans.
Tax benefits of a 403(b) plan
A 403(b) may also use pre-tax or after-tax dollars. Your employer may dictate which taxation method your 403(b) uses, or they may give you the opportunity to contribute to a tax-deferred 403(b) and a Roth 403(b), which uses after-tax dollars.
As with the 401(a), you usually cannot withdraw 403(b) funds before you turn 59 1/2 without paying a 10% early-withdrawal penalty. The 403(b) gives you the same withdrawal options as the 401(a).
403(b) contribution limits
You may contribute up to $19,500 to a 403(b) in 2020, or $26,000 if you're 50 or older. These are the same as the limits for 401(k)s, but 403(b)s have a special provision that enables employees with at least 15 years of service with their current employer to contribute up to $3,000 more per year.
There's a $15,000 maximum cap on these catch-up contributions, so if an employee chooses to contribute the maximum $3,000 per year, they may do so for only five years. After this they are limited to the standard contribution limit for the year.
Again, you shouldn't worry about choosing between a 401(a) and a 403(b) because you won't be offered both at one job. But if you work for a nonprofit and later change jobs, you might find your next employer offers a different type of account from what you had at your old job. So it pays to have a basic grasp of how 401(a)s and 403(b)s work. And ask your employer if you have questions about plan specifics. This will help you make the best decisions about how to save for your retirement.