Compliance Tips: Do You Understand How “Pick-up” Contributions Work?

A much-used but often confusing element of governmental retirement plans are “pick up plans,” where an employer pays -- or “picks up” -- an employee’s required contribution under the State’s public employment retirement systems.  

Employer contributions to state retirement systems are generally not included in an employee’s gross income. Required employee contributions to those same retirement systems, on the other hand, are included in an employee’s gross income even though that income is remitted to the State as required by statute instead of going to the employee.[1] Internal Revenue Code §414(h)(2) provides that, in any governmental plan where the contributions of the employer are designated as employee contributions but the employer “picks up” those contributions, the contributions are treated as employer contributions and thus not currently taxable to the employee. Instead the taxation is deferred until the benefit is distributed to the employee.  This is where the benefits of a “pick-up plan” come into play for employees, and particularly those employees a public employer wishes to reward and retain.

How to Establish a Pick-up Plan

Through revenue rulings and private letter rulings, the IRS has established the following requirements for pick-up plans:

1. The employer must specify that contributions, although designated as employee contributions, are being paid by the employer. This should be done through formal action of the entity’s governing body to provide that the contributions on behalf of the designated employees of the employer, although designated as employee contributions, will be paid by the employer in lieu of employee contributions. The resolutions should include the group of employees to be covered, the method of pick-up and the planned effective date;
2. Employees must not be given the option of choosing to receive the amount directly instead of having it paid by the employer to the retirement plan; and
3. The pick-up contribution cannot be retroactive. It must be effective after the board adopts a resolution implementing the pick-up plan.

Compliance Tip #1: The governing board must take formal action adopting the pick-up plan. This requirement is so important that OPERS offers to review your draft resolutions prior to adoption to ensure they comply with IRS and state regulatory requirements and provides sample language that can be used.

Ohio has recognized those rulings in relation to its public retirement systems and allows employers to provide various iterations of pick up plans for their employees.

Types of Pick-up Plans

An Ohio public employer can choose among three types of pick up plans for the benefit of its employees:

1. Salary Reduction - Contributions are deducted from employees’ salaries, but the deducted amounts are deferred for federal and state income tax purposes.  This has the effect of lowering the employee’s overall salary for purposes of computing their compensation recognized by the retirement system.
2. Fringe Benefit not Included in Compensation - Under a fringe benefit not included in compensation Pick-up Plan, the contributions are paid by the employer from the employer’s funds. The contribution is not deducted from employees’ salary. However, the employer-paid contribution is also not recognized as compensation to the employee for purposes of retirement system salary credit.
3. Pick-up on Pick-up - With a pick-up on pick-up plan, the retirement plan contributions are paid by the employer, and an additional contribution on the employer-paid contribution is also paid by the employer since the picked-up amount paid on the employee’s behalf is regarded as salary for purposes of retirement system salary credit. This plan provides the employee a higher salary for retirement plan purposes only. Public employers should note that many public officials’ compensation and fringe benefits are set by statute, including township trustees and fiscal officers. How the statute addresses compensation may impact the type of pick-up plan that can be provided to such employees.

Compliance Tip #2: Know and understand what type of pick-up plan your employees can use and notify OPERS when you adopt or change the pickup plan you are using.

Pick up plans provide a means by which a public employer can increase the dollars retained by its employees without having to increase the employees’ annual salary.  However, an employer should understand that it will bear increased costs in providing this benefit to its employees.  Where an employer chooses to provide a pick up option to a class of employees, it is important that it implements and administers the selected pick-up plan correctly. Compliance is crucial to both the employer’s and the employee’s obligations under both state and federal law – including tax laws --, and legal counsel should be consulted to ensure each of the required steps is appropriately completed in implementing these plans.

 

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[1] Employees who have 457 and 403(b) elective deferral plans available to them can realize tax savings by making additional elective deferrals under those permitted cash or deferred arrangements.