Change in Pick-up Contribution

[DTH]

A governmental 401(a) money purchase plan has a 4% pick-up contribution. The plan does not permit employees to make a one-time irrecocable election to not participate in the plan nor to elect to never make pick-up contributions. A collectively bargaining agreement (CBA) raised the 4% to 6% for existing employees. Can this be done via a CBA, a new employment agreement, or by the employer for non-union employees?

I had thought that once pick-up contributions start they can't be increased or decreased for any existing employees. From Rev. Ruling 2006-43:

Section 1.401(k)-1(a)(3) generally defines a cash or deferred election as any direct or indirect election (or modification of an earlier election) by an employee to have the employer (i) provide an amount that is not currently available to the employee in the form of cash or some other taxable benefit, or (ii) contribute an amount to a trust or provide an accrual for a plan deferring the receipt of compensation.

Thank you.

[Carol V. Calhoun]

The question is whether the increase in the contribution rate is done via "a direct or indirect election," or whether it happens automatically. If employees never had a chance to opt out of the increased contribution (either initially, or when the rates changed), the pick-up can be increased without jeopardizing its status as a pick-up. See Private Letter Ruling 201532036 (May 4, 2015).

My understanding is that the IRS will not treat a change in rates mandated by a collective bargaining agreement as an election, unless the situation is abusive (e.g., a collective bargaining unit is set up that covers only one employee).

I would be very nervous about having the change embodied in an employment agreement, however. The IRS generally takes the position that a change in an employment agreement is elective on the part of the employee. However, if the original employment agreement gave the employer the unilateral right to change the contribution (or specified that it would be changed if the rate for other employees were changed), there should not be an issue in treating the new rate as picked up.

And all of this leaves aside the issue of whether the employer can change the rate of contributions, as a matter of state law. In California, for example, an employer cannot unilaterally change the level of contributions taken out of an employee's wages.

[DTH]

Thank you Carol this is very helpful. I was not aware of the PLR.

If a plan permits employees to make a one-time irrecocable election to not participate in the plan, elect to never make pick-up contributions, or allows for them to elect their pick-up contributions under a range (e.g., 1% - 10% of compensation) would that change the answer?

Thank you.

[Carol V. Calhoun]

So long as the election is a one-time election upon initial hire or first participation in any plan of the employer, they should be fine. The legal issues tend to arise when an employer adopts a new plan (having already had a plan before) or adopts a new contribution formula under an old plan, and wants to allow employees to make new elections at that time. Because such an election is not on initial hire or first participation in any plan of the employer, it cannot be the basis for a pick-up.

I would point out that although a one-time election upon initial hire or first participation in any plan of the employer is permitted, it can often create employee relations issues. For example, an employee may elect a high rate of contributions upon hire, but later encounter financial reverses and want to lower the rate of contributions. This cannot be permitted. In some instances, we've seen employees resign and take other employment in order to escape the pick-up obligation and to obtain a distribution of the amounts previously contributed.

Conversely, if an employee initially elects a low rate of contributions, but later wants to increase the rate of contributions to obtain a better benefit, any such increase can be allowed, if at all, only on an after-tax basis.

Given that an individual may remain in employment for many decades, holding the 60-year-old to an election he or she made at 20 will often strike employees as unfair. And of course, both employees who want to raise their contributions and those who want to lower them may later argue that they did not fully understand the irrevocability of their initial elections. It is critical to ensure that communications with them are fully documented.