Advantages of Using a 401(a) Defined Contribution Plan for Employer Contributions
- No offset against the 457 Plan contribution limit
- Contributions are not subject to FICA tax as in a 457 Plan
- A vesting schedule can apply to the contributions
- Participant loans can be made available
- The IRS 10% early withdrawal penalty can be avoided after age 55 (instead of 59½)
How contributions are taxed in a 401(a) plan
Participants do not pay income taxes on contributions or earnings until they make a withdrawal or are transferred to their beneficiary. Contributions may remain tax deferred and allows them to compound until the participant is eligible to take withdrawals for retirement.
Key Features of a 401(a) plan
- You can set up a 401(a) plan to cover specified employee groups
- Eligibility requirements can include up to age 21 and two years of service (1,000 hours each year)
- Contributions are discretionary each year, but must be substantial and recurring
- Contributions are allocated according to a formula specified in the plan
- Ownership of an employee’s account can be tied to a vesting schedule based on years of service
- The participant’s vested account balance is generally payable upon retirement, severance from employment, disability or death
- Taxable distributions on account of disability, death or after age 55 and severance from employment avoid the IRS 10% early withdrawal penalty
- Employees can defer any or all distributions until they are subject to IRS minimum distribution rules
- Younger and long-term employees may benefit the most because they have more contribution opportunities and a longer period of tax-deferred earnings