BillAsay

DROP and "Pick-up" Arrangements

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BillAsay    0

A couple of years ago I was attending the annual conference of the IFEBP. I attended a public employer session and the speaker was from the federal government. At that time we were told that they were currently reviewing a question regarding DROP's and "pick-up" arrangements. Plans that included a DROP provision and an IRC 414(h)(2) "pick-up" arrangement, whereby when a DROP provision mandated that those electing to participate in the DROP would no longer contribute to the plan, may be running afoul of the 'pick-up" and/or CODA rules. Since those electing to participate in the DROP would no longer contribute to the pension plan, the question was being reviewed because participating in the DROP was considered optional and may not comply with the "mandatory" requirement of a "pick-up" arrangement.

Since then, I have not seen an answer to this question. Does anybody know the outcome of this review?

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I have not seen specific guidance on this issue, but I seriously doubt that the IRS would allow an employee to make any kind of election (including an election of a DROP plan) that would affect the pickup. For a long time, the IRS permitted various "one-time elections" that related only to specific compensation to be used to establish a pick-up arrangement. For example, an employee who elected to purchase service credit could be permitted to have that purchase done on a pickup basis, or an employee entering a new plan could be permitted to elect to have picked up contributions made to that new plan. However, in Rev. Rul. 2006-43, the IRS stated that a pickup cannot be a cash or deferred arrangement.

Treas. Reg. 1.401(k)-1(a)(3)(v) provides as follows:

A cash or deferred election does not include a one-time irrevocable election made no later than the employee's first becoming eligible under the plan or any other plan or arrangement of the employer that is described in section 219(g)(5)(A) (whether or not such other plan or arrangement has terminated), to have contributions equal to a specified amount or percentage of the employee's compensation (including no amount of compensation) made by the employer on the employee's behalf to the plan and a specified amount or percentage of the employee's compensation (including no amount of compensation) divided among all other plans or arrangements of the employer (including plans or arrangements not yet established) for the duration of the employee's employment with the employer, or in the case of a defined benefit plan to receive accruals or other benefits (including no benefits) under such plans.

Example 5 of that regulation reads as follow:

(i) Employer B establishes a money purchase pension plan in 1986. This is the first qualified plan established by Employer B. All salaried employees are eligible to participate under the plan. Hourly-paid employees are not eligible to participate under the plan. In 2000, Employer B establishes a profit-sharing plan under which all employees (both salaried and hourly) are eligible. Employer B permits all employees on the effective date of the profit-sharing plan to make a one-time irrevocable election to have Employer B contribute 5% of compensation on their behalf to the plan and make no other contribution to any other plan of Employer B (including plans not yet established) for the duration of the employee's employment with Employer B, and have their salaries reduced by 5%.
(ii) The election provided under the profit-sharing plan is not a one-time irrevocable election within the meaning of paragraph (a)(3)(v) of this section with respect to the salaried employees of Employer B who, before becoming eligible to participate under the profit-sharing plan, became eligible to participate under the money purchase pension plan. The election under the profit-sharing plan is a one-time irrevocable election within the meaning of paragraph (a)(3)(v) of this section with respect to the hourly employees, because they were not previously eligible to participate under another plan of the employer.

Thus, any election into a picked up contribution must truly be irrevocable upon the employee's first participation in any plan of the employer, and cannot be modified even if the employer adopts a new plan. The IRS has recently reiterated the conclusions of Rev. Rul. 2006-43 in Private Letter Ruling 201425026.

Based on the above analysis, I think it extremely unlikely that the IRS would permit an employee to make an election during employment that would end the pickup, even if it were for the purpose of participating in a DROP plan.

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