Can a government plan be a profit sharing plan? Discretionary or nondi

[Guest PALAWYER]

Can a government agency of a state start a discretionary profit sharing plan- how about nondiscretionary?

Can this plan include pick-ups under 414(h)(2)?

Hard to find materials on this- would appreciate help!

[BillAsay]

I believe that they could have a profit sharing plan. Most of the new governmental DC plans in Pennsylvania have been Money Purchase plans. However, an IRC 414(h)(2) "pick-up" is for mandatory contributions only. It recharacterizes employee contributions as employer. Also, if this plan qualifies for state aid under Act 205 of 1984, anything other than a flat percentage or flat dollar amount could cause unexpected funding problems.

[Carol V. Calhoun]

Yes, a governmental plan can be a profit-sharing plan. See Code section 401(a)(27).

There is no specific bar to having contributions to a profit-sharing plan picked up. Of course, they would have to meet the requirements for a pick-up--e.g., be either mandatory or subject to an irrevocable one-time election on the part of the employee.

[Guest David G]

Why would you want to have mandatory employee contributions to a profit sharing plan? Wouldn't it become closer to a money purchase plan, but without the required employer contributions? Having required employee contributions to a plan without required employer contributions seems somewhat harsh on employees.

[Carol V. Calhoun]

Sometimes a profit sharing plan is used when there are employer as well as employee contributions, if the employer wants to have flexibility about the amount of employer contributions each year. For example, you could have a plan in which the size of the employer contribution would depend in part on the achievement of certain goals (financial, educational, you name it).

Also, remember that not all "mandatory" contributions are truly mandatory. I have heard of at least one jurisdiction which is using a profit sharing plan like a 401(k) plan, except that instead of being able to make annual elections as to the amount of their tax-deferred contributions, employees must make one irrevocable election and stick with it for the duration of their employment. While one could raise practical questions about such a plan, it would be legal under federal law. (As always with governmental plan, you would need to check to make sure it was legal under applicable state and local law.)

[PMC]

Regarding the Profit Sharing and Money Purchase scenarios under 414(h) - Under a MPP an employee could not withdraw those 414(h) "pick-up" prior to termination of employment. But if it is a Profit Sharing version can an employee withdraw those 414(h) "pick-up" contributions since they are considered employer contributions.

Also, is it possible for an employee to suspend 414(h) contributions (e.g. for hardship reasons) under either the mandatory or irrevocable scenarios discussed above?

[Carol V. Calhoun]

As to the second question, definitely not--which is one of the big issues with pick-up contributions. But the first question is interesting. Normally, pick-ups must be irrevocable, but then again, normally you can take withdrawals from a profit-sharing plan after they have been in the plan for 2 years, or after you have 5 years of service. The question is whether the IRS would treat generous withdrawal rules for picked-up contributions as an end run around the irrevocability rules. My own view is that they shouldn't, because there would be no problem with having those withdrawals in the case of normal employer contributions, and 414(h)(2) is intended to treat picked-up contributions for income tax purposes as though they were employer contributions. But I have never seen any authorities discussing this.