Pick up Contributions

[Kitty]

Do or can some Defined benefit plans prohibit employee contributions?

If there are plan rules that prohibit employee contributions, do employer pick-ups 'circumvent' that rule?

Because the wage rates cannot have been the same as they otherwise would have been but for the contribution if no employee contribution would have occurred. Is that a correct assumption?

[ETA Consulting LLC]

You're thinking logically; don't do that Pickup contributions are the result of an anomaly where the "employer" funds the contribution and merely "designates" it as being funded by the employee. That would normally imply a non-elective contribution since it was not being made pursuant to any employee election, but made totally by the employer. That is not the case. This contribution is a pre-tax contribution, but is not counted against the employee's 402(g) limit.

The question, then, becomes: If it is an "employee contribution", then shouldn't it be subject to FICA? It's not if the employee can find an governmental agency to pick up the contribution in their plan and record is as a non-elective.

I am still a little shaky on these rules and am going from memory; but do know it defies logic in many instances.

Good Luck!

[Carol V. Calhoun]

First, it is quite common for a defined benefit plan to prohibit employee contributions. In the private sector, it is actually fairly unusual to find a defined benefit plan that permits them.

Second, a pick-up technically refers to a situation in which an employer pays a contribution referred to in the plan as an employee contribution. So if there is no provision in a plan for employee contributions, technically there is no pick-up.

If the plan provides for employer contributions beyond those mandated, the employer could make such contributions (and might be able to reduce employees' salary to reflect this). However, most defined benefit plans that preclude employee contributions also make no provision for employer contributions beyond the mandated amount. As the name suggests, a defined benefit plan typically provides a benefit that is defined in the plan, and mandates employer (and in some instances, employee) contributions to fund that benefit. If that basic structure is followed, additional employer contributions would not create any corresponding increase in the benefits provided to employees, and thus no employer would make them. If a defined benefit is to accept additional employer or employee contributions to increase employee benefits under the plan, it needs to provide explicitly for such contributions, and specify how they will increase the benefits of employees (e.g., are they allocated to a separate account for each employee, or do they provide for a percentage increase in the defined benefit for each employee?), in order to avoid issues with the definitely determinable benefits rule.

[Kitty]

I'm a bit confused as to whether ONLY 'government' plans can use pickups or if any organizations that have defined benefit pensions (that were created and qualified as tax exempt plants under 401(a) and 501(a))

permits those plans to use pick ups as well? ? I hope I'm making sense here as I'm new to benefits and trying to fully grasp how they work. Lol

[Kitty]

First, it is quite common for a defined benefit plan to prohibit employee contributions. In the private sector, it is actually fairly unusual to find a defined benefit plan that permits them.

Second, a pick-up technically refers to a situation in which an employer pays a contribution referred to in the plan as an employee contribution. So if there is no provision in a plan for employee contributions, technically there is no pick-up.

I'm very visual, so I tried to lay out a set of examples to make sure I was understanding the process.

1)

Employee A has a $30,000 salary, and required $10,000 employee contributions.

A's salary is therefore $20,000

Employee would pay taxes and FICA in first example.

2)

Employer pick up via salary reduction:

*Employee A gets $20,000 salary

Employer 'pays' employee A $30,000 and reduces that by $10,000

so the employees salary: IS the same but for the contribution.

The employee gets a tax benefit by having his employer pay the contribution. His pay essentially didn't change so his wages: ARE the same but for the contribution. Employer paid contribution so no FICA.

3) The union representing B negotiated an agreement with the company under which it would participate in the pension. The agreements states the company will reduce salary and contribute it as a (employer) contribution.

^not sure this is legal, but for sake of the illustration I'm using it.

Employee B has a salary of $30,000 and no required 'employee' wage contributions.

The employees salary is therefore $30,000.

The plan requires (employer?) contributions of $10,000.

Employer pays employee a $30,000 salary and reduces it by $10,000 and contributes it as an 'employer contribution'.

The employees salary is now $20,000.

So, if I understand, The wages are NOT the same but for the contribution? FICA in this example I'm not sure on.

*Edited to correct employee A's salary to $20,000 (not $30,000. That was a typo).

[Carol V. Calhoun]

"Pick-ups" apply only to governmental plans. Under Code section 414(h), the general rule is that any contribution that the plan calls an "employee" contribution is after-tax. Section 414(h)(2) (the "pick-up" provision) provides an exception that allows an employee contribution to a governmental plan (and only a governmental plan) to be treated as an employer contribution (and therefore made pretax) if certain requirements are met.

As to your examples:

1. In Example 1, you are correct that the contribution is subject to both income and FICA taxes.
2. In Examples 2 and 3, the contribution is not subject to income taxes (assuming that the employee has no option to receive the amount in cash instead of having it contributed to the plan). However, because the contribution reduces the employee's salary, it is subject to FICA taxes.

As an alternative, the employer could simply agree to pay B a salary of $20,000, and to pay the $10,000 contribution without a salary reduction. In that case, the contribution would be free of both income and FICA taxes. Clearly, the economic effect is identical to that described in 2 and 3, so it might at first blush appear incomprehensible that the tax consequences would be different. However, the thinking seems to be that the employer can go either way, but must pick one, so that an employee cannot get the benefit of reduced FICA taxes now and then argue years later that Social Security benefits should be based on the full unreduced salary.

[Kitty]

Thank you!

I figured if I tried to talk it out by creating scenarios on paper it might make more sense to me but it still was confusing.

One clarification: Salary reduction is in reference to the pretax wages BEFORE calculating the gross line on a paycheck?

If we were talking about say one pay check (I will drop some zeros from the prior example) is this how a salary reduction would appear? (I'm not figuring out NET since there's no real way to determine what elections, deductions, what state *taxes etc. would be deducted so this is* just for visual comprehension as place holders lol.)

PAYCHECK Employee B

Wage: 10 hours @ $30 per hour $300.00 ---------ytd $30,000

Pension: 10 hours @$10 per hour -$100.00---------ytd $10,000

-----------------------------------------------------------------------------------------

Gross pay: $200.00--------ytd $20,000

State Taxes:

FICA:

NET pay:

One last piece I seem to be missing in fully grasping pick ups is the fica...Im going to go back and re-read the IRC to try and comprehend that part.

Reading tax laws isn't the same as reading a juicy novel! They're a bit dry and leave things unspoken for when you're new and things aren't familiar yet.

*edited a piece of sentence that was incorrect grammatically

[Kitty]

[*]In Examples 2 and 3, the contribution is not subject to income taxes (assuming that the employee has no option to receive the amount in cash instead of having it contributed to the plan). However, because the contribution reduces the employee's salary, it is subject to FICA taxes.

As an alternative, the employer could simply agree to pay B a salary of $20,000, and to pay the $10,000 contribution without a salary reduction. In that case, the contribution would be free of both income and FICA taxes. Clearly, the economic effect is identical to that described in 2 and 3, so it might at first blush appear incomprehensible that the tax consequences would be different. However, the thinking seems to be that the employer can go either way, but must pick one, so that an employee cannot get the benefit of reduced FICA taxes now and then argue years later that Social Security benefits should be based on the full unreduced salary.

I made a typographical error in trying to understand the differences in the salary pick ups with my first reply and just noticed it!

I edited the reply to correct employee A's salary in example #2 to $20,000 (not $30,000. That was a typo).

Is your answer still the same? I'm sorry!

[Kitty]

You're thinking logically; don't do that Pickup contributions are the result of an anomaly where the "employer" funds the contribution and merely "designates" it as being funded by the employee. That would normally imply a non-elective contribution since it was not being made pursuant to any employee election, but made totally by the employer. That is not the case. This contribution is a pre-tax contribution, but is not counted against the employee's 402(g) limit.

Is that accidentally backwards? Pick ups are an anomaly where the "employee" funds the contribution and (the employer) merely designates it as being funded by the "employer"? (See my example #3)

The question, then, becomes: If it is an "employee contribution", then shouldn't it be subject to FICA? It's not if the employee can find an governmental agency to pick up the contribution in their plan and record is as a non-elective.

I am still a little shaky on these rules and am going from memory; but do know it defies logic in many instances.

In having a Governmental agency doing the 'pick up' it makes it not subject to fica?

Or the 'non-elective' part makes it not subject to FICA?

Or both are required to make the wages not subject to FICA?

>Aren't trusts (organizations) that are tax exempt by 401(a) and 501(a) considered a 'governmental employer' under this pick up rule? I could have sworn I read that. That's my basis for my questioning. Tax exempt 401(a)/501(a) organizations and pick-ups.

[joel]

A tax exempt entity is not a governmental entity. A tax exempt entity is i.e. a research foundation. A governmental entity is i.e. the State of New Jersey.

I believe you are confusing the tax-exempt status of the DB trust with the tax status of the employer sponsor. Section 401(a) applies with equal vigor to governmental DB plans and to DB plans of tax-exempt organizations. The issue at hand applies to just governmental DB plans.

[david rigby]

Section 401(a) applies with equal vigor to governmental DB plans and to DB plans of tax-exempt organizations.

Well, parts of 401(a). See for example, 401(a)(5)(G), or 401(a)(10), 401(a)(24), 401(a)(26).

[joel]

Thank you David, I stand corrected.

[Kitty]

So it seems if no employee contributions are required as in example 3, and it were non governmental, then pick ups wouldn't be relevant anyhow.

[Carol V. Calhoun]

If the plan is not governmental, pick-ups are irrelevant regardless of any other factors. You need to look at Internal Revenue Code section 414(h)(2).

Rule for nongovernmental employers: If the plan calls a contribution an employee contribution, it is after-tax, regardless of any other factors. Internal Revenue Code section 414(h).

Rule for governmental employers:

1. Income tax: Contribution is "picked up," and therefore pretax for income tax purposes, only if three requirements are met: a) the plan calls a contribution an employee contribution, b) the employer agrees to pay it, and c) the contribution is nonelective. "Nonelective" means that the employee either a) has no option as to whether the salary reduction will occur, or b) has only a one-time option as to whether the salary reduction will occur upon initial hire or initial participation in any plan of the employer. The employer can pay the contribution a) in addition to wages, or b) via salary reduction. As you suggest, salary reduction means that although the employee is nominally paid $30,000, only $20,000 appears on the W-2 after reduction by the $10,000 pension contribution.
2. FICA tax: A picked-up contribution is exempt from FICA tax only if in addition to the three requirements of #1, above, the employer pays the contribution in addition to wages, not via salary reduction. So in our example above, FICA taxes would be due unless the employee received the full $30,000, and the employer paid the $10,000 contribution in addition to that.

While all governmental entities are tax-exempt, not all tax-exempt entities are governmental. A 401(a) trust, a charitable organization, and many other entities are tax-exempt, but not necessarily governmental.

[Kitty]

Rule for nongovernmental employers: If the plan calls a contribution an employee contribution, it is after-tax, regardless of any other factors. Internal Revenue Code section 414(h).

Rule for governmental employers:

Income tax: Contribution is "picked up," and therefore pretax for income tax purposes, only if three requirements are met: a) the plan calls a contribution an employee contribution, b) the employer agrees to pay it, and c) the contribution is nonelective. "Nonelective" means that the employee either a) has no option as to whether the salary reduction will occur, or b) has only a one-time option as to whether the salary reduction will occur upon initial hire or initial participation in any plan of the employer. The employer can pay the contribution a) in addition to wages, or b) via salary reduction. As you suggest, salary reduction means that although the employee is nominally paid $30,000, only $20,000 appears on the W-2 after reduction by the $10,000 pension contribution..

I consider the employer non governmental based on the first criteria.

In a defined benefit plan, as suggested, salary reduction means that although the employee is 'nominally'* paid $30,000, only $20,000 appears on the W-2 after reduction by the $10,000 pension contribution. *Is that $10,000 being reduced considered employee wages if they never actually receive it, and its not taxed?

The plan does not call it an employee contribution, but is 'reducing the wage rates' by the contribution amount and then contributing that wage reduction amount to the pension. The pension is then calling it an employer contribution.

*edited for errors when trying to quote

[Carol V. Calhoun]

If the plan is nongovernmental the whole $30,000 must be included on the W-2, and is taxed, if the $10,000 pension contribution is stated in the plan to be an employee contribution. This is true even though the employee never actually receives it and indeed has no way to receive it.

[Kitty]

The

The plan does not call it an employee contribution, but is 'reducing the wage rates' by the contribution amount and then contributing that wage reduction amount to the pension.

The pension is then calling it an employer

Let me rephrase: The Pension calls it an employer contribution.

The Employer reduces the Employees 'wage rates' specified in the c.b.a. by the contribution amount and contributes it to the pension as an employer contribution. No FICA.

[david rigby]

The Employer reduces the Employees 'wage rates' specified in the c.b.a. by the contribution amount and contributes it to the pension as an employer contribution.

Is this specified in the CBA (not the plan)?

[Kitty]

The Employer reduces the Employees 'wage rates' specified in the c.b.a. by the contribution amount and contributes it to the pension as an employer contribution.

Is this specified in the CBA (not the plan)?

Yes, Via a memorandum of agreement (m.o.a.) modifying the c.b.a.'s negotiated wage rate lower.

.

[Katherine Woji]

Great discussions--have a question for @Carol V. Calhoun

For a governmental pick-up plan, would the employer/government be able to pickup any catch-up contributions? Specifically, say if there is a 401(a) government defined contribution plan, would the employer be able to pick up contributions over the $55,000 annual combined limit to $61,000 ($6,000 in catch-up contributions)?

Thanks very much in advance for your thoughts. 

[tja]

One of the earlier posts addressed the point that a if pick-up arrangement reduces salary, FICA is owed.  Assuming  salary has not been reduced, an IRS website nonetheless states there is a FICA obligation unless such picked-up contributions are mandatory for  "all employees covered by the retirement system.”   See https://www.irs.gov/government-entities/federal-state-local-governments/employer-pick-up-contributions-to-benefit-plans

That seems incorrect and I can find no authority for the IRS's position. Does anyone have any insights?

 

[Dobber]

I am looking resurrect this very informative thread. 

An individual has a 401a program through a public employer (community college) & participates in a 401k with a private employer

The 401(a) allows for employee contributions.  Would these be deemed "pick up" contributions and thus not subject to the 402(g) limit? Individual wants to max his 401(k) deferral limit ($20,500) and make employee contributions to the 401(a) plan

Is there ever situation/scenario where a 401(a) plan sponsored by a gov't entity allows for pre-tax salary deferrals (that would be included in the 402g limit)?  I recall something about grandfathered $ Purchase plans allowing deferrals but then again I could off base. 

Thank you