Purchasing Service Credits in Pension Question

[Zoraster]

I'm a city manager that has been working 4 years at a city with its own pension plan. I came in under a 457/401a defined contribution benefit which is fairly typical for cms. I recently renegotiated my contract that allows me to effectively participate in the pension and receive past service credits and then if I hit vesting (10 years) I transfer over my 457 balance to the pension.

My Questions:

1) How do I "buy" the past service credits? Can the City cut the pension a check directly; or can they gross up my wages and then deduct it from me on a payroll deduction; or do they need to make additional contributions to my 401a/457b equal to the purchase amount and then I purchase it as a rollover/transfer? The way my contract reads; the prior service credits are a part of my compensation.

2) If I reach vesting and rollover my 457 and/or 401a to the pension, is this done on a pretax basis?

3) Do I need to amend the plan to help facilitate the above? The pension buy in language is pretty vague, suggesting just that an employee can buy back any number of years of service with the city and up to 5 years from other governmental experience; nothing really in there about 457 rollovers or payroll deduction or anything; it just says you can do it.

Any insight or direction would be greatly appreciated.

[Carol V. Calhoun]

1. Plan-to-plan transfers from an eligible 457 plan to a governmental defined benefit plan for permissive service credit purchases can be made at any time, provided that the plans permit such transfers, and you do not need to be eligible for a distribution at the time the transfers are made. The trust or annuity used to hold the assets of the 457 plan would cut the check directly to the defined benefit plan. Thus, no deductions from wages would be necessary to the extent the money came from the 457 plan. Moreover, this would not be a rollover, because a rollover occurs only if you are entitled to a distribution.

To the extent that the cost of the service credit purchase is greater than the amount in the 457 plan, the way to make the extra contribution pretax is to have the defined benefit plan provide for the additional benefit for you, and for your employer to contribute directly to the plan to fund the benefit. That language would have to provide that the contribution was mandatory on your employer's part, and that you could not receive the amount in cash by declining the contribution. If you simply pay for the purchase of service credit out of your wages, it would be on a post-tax basis.

2. As stated above, the movement of money from the 457 plan to the DB plan would not be a rollover, but a plan-to-plan transfer. Such a transfer is not taxable to you. However, as stated above, the contributions to the DB plan that exceed the 457 amount may or may not be pretax, depending on how they are structured.

3. The plan language needs to provide for the transactions. I'm not sure how "vague" the language is now, and whether it could be construed to cover your situation. However, for example, if it provides that purchases of service credit can occur only through payroll deduction, you'd need to have both plans amended so that the transfer from the 457 plan to the DB plan was allowed. Even if the plans already provide for plan-to-plan transfers to purchase service credit, the DB plan might need to be amended if the employer is to make contributions to fund that portion of the benefit not covered by the 457 plan.

[Zoraster]

Wow, thank you. That is exactly what I needed. I'll be setting up a meeting with the pension attorney and board chairman to draft the necessary language.

[david rigby]

Just a thought: Some of the phrasing above might be a bit vague.

If "the pension attorney" is employed by the city and/or the plan, then that person is not (necessarily) on your side. If so, you might consider whether you need your own legal counsel.

If Carol is licensed in your state, you could do worse. If she isn't, she (or another reader) may be able to provide a referral.

[Peter Gulia]

A client would be very lucky to engage Carol Calhoun’s advice.

In choosing a lawyer to give advice about employee-benefit plans, one need not restrict one’s choice to lawyers located in a particular State.

A State can’t regulate a lawyer’s practice if that regulation is preempted by Federal law or would preclude practice authorized by Federal law. Sperry v. Florida ex rel. Fla. Bar, 373 U.S. 379 (1963). A lawyer admitted to law practice in any State may anywhere give advice about Federal law if the lawyer limits her practice to her authorized Federal practice. See, e.g., Surrick v. Killion, 449 F.3d 520 (3d Cir. 2006). For example, a lawyer who labels her practice as limited to Federal tax law may do that practice anywhere.

Moreover, a lawyer may give advice about any State’s law if she does so while present in a State for which she is admitted to law practice.

[BTG]

Carol, your post mentions that the original poster's circumstances would not involve a rollover and I agree. However, I have seen many governmental DB plans that do permit the use of rollovers to purchase service credit, and I believe you have previous posts on this message board which indicate that this is permissible. Are you aware of any authority that explicitly confirms this? Or is the analysis simply that the rollover to the plan is permissible under 402© and nothing prevents that rollover from being used to purchase service credits?

Thank you very much for your insight.

[Zoraster]

As a follow up, the current plan allows the buyback at the full acturial cost.

From what I have gathered from the feedback above and additional research, the plan could be amended to allow for the Employer to pickup the contribution under 414(h)(2) provided that the employee did not have the option to receive the contributed amount directly instead of having them paid by the Employer to the pension plan.

I've also gathered that the permissive service credit in order to qualify under 415(n)(3)(iii) the participant must make a voluntary additional contribution which "does not exceed" the amount necessary to fund the benefit (which means that it could be less).

The current pension language requires that the service credit contribution be equal to the full actuarial cost. Below is an excerpt from the plan:

1. The Active Participant contributes to the pension fund an amount actuarially determined such that the crediting of service does not result in any cost to the fund plus payment of costs for all professional services rendered to the board in connection with the purchase of years of credited service."

My question is, when I'm amending the plan to provide for the Employer pickup contribution of the service credit can the contribution be changed to be less than the full actuarial cost in the event the Employer picks it up without changing the standard for everyone else or can that not be done? The rationale would be since the employer is paying for it either way does it matter if it is up front or down the road as a result of the increase to unfunded liability? On a practical level and the reason why I'm asking is, if the total cost was $100k that would be more problematic than paying $30k up front and absorbing the remaining $70k as an unfunded liability since we have a high funding ratio in the plan (~95% I believe).

Below is the language I'm looking to add as sub points to the language above:

1. The whole or portional amount required for the purchase of permissive service credits may be provided by a plan to plan transfer from an Eligible Retirement Plan to the pension fund.
2. Notwithstanding the previous, the Employer may elect by formal action to pick up the whole or portional amount of the contribution required for the purchase of permissive service credits for an Active Participant or to grant whole or portional permissive service credits to an Active Participant without contribution. It is the intent of this provision that said pickup contribution shall be pursuant to IRC § 414(h)(2) and not result in reported wages, withholding, or taxable income to the Active Participant. In so doing the Employer affirms that:
   1. Any contributions, although designated as employee contributions, are being paid by the Employer in lieu of contributions made by the employee; and
   2. The Employee does not have the option to receive any contributed amounts directly instead of having them paid by the Employer to the pension plan.

This language is my attempt to address what Carol had mentioned regarding the authorization for the plan to plan transfer as well as the Employer pickup contribution. The underlined section above is what my question is in regards to (I'm also hoping that the other language works as well). I'm sure the Board attorney will redline it or rewrite it entirely but I like to have my own starting point in ordinance language.

I've reached out to the Board attorney and we're trying to set up a meeting after the first of the year. He should be able to answer these questions too although I like having the answers before I ask the question. If I don't get a definite answer here beforehand I'll post whatever I find out from him for the sake of closing out the information on the thread.

Thanks everyone! (Especially Carol. My "additional research" mostly relied upon Carol's "Checklist of Federal Tax Law Rules Applicable to Public Retirement Systems" and the related content links; pure gold).