FINANCIAL MANAGEMENT/401(a) plans offer alternatives

With unemployment at its lowest level in nearly three decades, states, counties and municipalities across the country are finding the competition for skilled employees tougher than ever. In what has become a sellers’ market, workers are demanding – and getting – higher wages, richer benefits and new job-related perks.

Matching government employees’ contributions to 457 deferred compensation retirement plans is an increasingly popular benefit in the current tight labor market. Although they are a fairly new phenomenon in the government pension market and are not yet widely available, 457 plans have recently created a groundswell of interest among government entities.

The 457 plan is similar in many ways to its corporate cousin, the highly popular 401(k) plan. Both allow employees to regularly and systematically set aside a portion of their salaries toward retirement.

That money is invested in one or more investment options selected by each employee from a predetermined menu. Once the employee retires, the money can be used to create a regular stream of income during retirement.

Unlike 401(k) plans, however, 457 plans typically do not include employer matching contributions. That presents a problem, since, in the private sector, corporations have learned that attractive matching formulas in their 401(k) plans provide key benefits: They make it easier to both attract and retain employees, and they encourage employees to participate actively in building their retirement savings.

To take advantage of those benefits, a new defined contribution plan, the 401(a), has been created. The 401(a) can be established as a stand-alone plan or as a complement to an existing 457 plan. It offers employers and employees a great deal of flexibility by providing a matching system currently not available with 457 plans.

When set up alongside a 457 plan, the 401(a) often offers substantially similar or identical investment options. The combination allows employees to select investment options that mirror their individual investment objectives.

But, with a 401(a) plan, a state, county or municipality can match a percentage of each employee’s contribution to a 457 plan through a contribution to the 401(a). The employer match in 401(a) plans would be similar to that in 401(k)s, typically a 50 percent match, up to 5 or 6 percent of the employee’s salary.

Additionally, 401(a) plans are portable; employees can take their money with them if they change employers. And, while employees can only transfer their individual 457 plan account balances into other 457 plans, they can roll their assets from a 401(a) plan into any other qualified retirement plan.

However, unlike 457 plans, 401(a) plans do not allow employees to contribute money on a pre-tax basis. (Employer contributions are pre-tax.) In addition to that, the new plans have a few other drawbacks. For example, if the 401(a) plan is not replacing an existing retirement plan – such as a defined benefit plan – the matching contribution will most likely result in extra costs to the government entity.

Additionally, the introduction of a 401(a) plan may necessitate negotiations with the appropriate employees’ union. Finally, government entities must educate employees about the new retirement benefits. That can be a plus, though, since the added layer of education can encourage greater participation in existing defined contribution retirement plans.

Still, given the success of participation rates in 401(k) plans with matching contributions, matching deferrals under a 401(a) plan should increase employee participation in 457 plans.