Investment Strategies

A Medical Professional’s Guide to the 401(a) Plan

If you’ve looked into passive income for doctors, you’ve likely learned that retirement plans can be a viable option.

Amidst familiar options like the 401(k) and the IRA, you may have come across the 401(a) plan.

This article explains everything about this retirement investment option, including eligibility criteria, benefits, and drawbacks.

Key Takeaways

A 401(a) plan is a retirement savings option for government, nonprofit, and educational employees.
Employers and employees can both contribute to 401(a) accounts.
Eligibility requirements for participation include being at least 21 and serving a minimum of one year with the employer.
Benefits include deferred tax and rollover options
Drawbacks include high costs and early withdrawal penalties.

What Is a 401(a) Plan?

A 401(a) plan is a retirement plan for employees of:

US federal and state government agencies;
Agencies of Indian tribal governments;
Nonprofit organizations; and
Educational institutions.

It’s set up to help government employees accrue income they can fall back on when they reach the normal retirement age of 67 years.

Doctors who work for the above-mentioned employers are also eligible for a 401(a) plan.

How a 401(a) Plan Works

Like the more widely-known 401(k) plan, a 401(a) plan is powered primarily by employer contributions, though both the employer and employee can contribute.

The employer decides everything from the plan’s structure and vesting schedule to whether their staff can make voluntary or mandatory employee contributions.

The money that an employer pays into the 401(a) retirement account can come from either the pre-tax dollars or after-tax dollars earned by the employee.

Employers can elect to contribute a fixed dollar amount or a fixed percentage from the salaries of eligible employees.

Employees make voluntary contributions to a 401(a) plan with after-tax dollars.

In other words, they contribute from their income after the employer has deducted the 401(a) contribution and the government has taxed what’s left.

As is the case with 401(k) contributions, the money in a 401(a) plan retirement account is invested on the employee’s behalf.

Employers offer multiple investment options, like:

Stocks
Bonds
Exchange-traded funds; and
Mutual funds

Like other income taxes, any profits earned on the money in a 401(a) plan account are taxable.

Eligibility Requirements

The IRS has general eligibility requirements that employers must adhere to.

These IRS rules state that employers must allow an employee to participate in a retirement plan if:

They’re aged 21 or above; and
They’ve served for a minimum of one year.

Also, the IRS prohibits employers from excluding employees from participating in retirement plans after they’ve reached a specified age.

Contribution Limits

At the time of writing, 401(a) plans have an annual contribution limit of $345,000.

See section 401(a) 17 of Title 26 of the Internal Revenue Code for the full details.

Benefits of a 401(a) Plan

Contributions under a 401(a) plan provide the following benefits to eligible medical professionals:

Deferred Tax

While it’s true that you’ll pay taxes on the profits earned from investments made with your 401(a) plan contributions, it won’t happen annually or immediately.

You won’t have to worry about paying tax on your capital gains, interest, dividends, or other gains until you become eligible to make withdrawals.

Here’s a tax worksheet you can use to calculate your dividends and capital gains when you’re ready to take the plunge.

Rollover Option

Employees with 401(a) plans can roll over their contributions to other retirement plans.

The most common instance is where an employee leaves one government agency for another.

If the new employer sponsors another qualified retirement plan, the 401(a) plan contributions will roll over to the said plan.

Eligibility for All

If your employer elects to make contributions on behalf of their employees, they must do so for everyone, regardless of whether they volunteered to contribute to their own plan.

Drawbacks of 401(a) Contributions

The drawbacks associated with 401(a) plan contributions include:

Cost

If you work for an employer that imposes mandatory contributions, the cost of financing the plan may be too high.

This drawback will be especially acute if you’re not a high earner.

The reason is that your income will be subject to three deductions: your employer’s contribution, your own contribution, and the income tax you’ll pay to the government.

Penalties

401(a) contributions attract a penalty for an early withdrawal of the contribution amounts.

For example, when employees leave one employer for another who doesn’t sponsor such plans, they’d have no choice but to take the lump sum payment.

The same is true when they quit a job and have no plans to get a new one.

Frequently Asked Questions

What’s the Difference Between a 401(k) and a 401(a)?

The main difference between the two retirement plans is the employer sponsoring them.

For-profit organizations typically offer 401(k) plans to their employees, whereas government agencies, universities, and tax-exempt organizations (nonprofits) offer 401(a) plans.

Also, while the eligibility requirement for 401(a) is one year of service, 401(k) plans require two years.

What Does Vesting Mean in 401(a)?

The term vesting refers to when the funds that have been contributed to a 401(a) become accessible.

401(a) vesting schedules fall into two categories: immediate, in which case, the employee can access the funds immediately (subject to penalties); or gradual.

Can I Roll Over Funds from a 401(a) Plan to a 403(b) Plan?

Yes, you can. However, it’ll ultimately depend on whether your new employer is okay with rollover contributions to 403(b) plans.

Final Thoughts

401(a) plans offer a pathway for eligible doctors to earn passive income while saving for retirement.

If your employer falls into the category of 401(a) sponsors, you could take advantage of this investment vehicle.

Contact us and speak to one of our specialists about how a 401(a) or other governmental plan can help you, the investment choices available, and more.