Chapter 22: Social Security Replacement Plans – An Introduction

For many American workers, the Old-Age, Survivors, and Disability Insurance (OASDI) program serves as an important component of their retirement savings. This is not necessarily the case for the millions of workers whose State, local government and public agency employers have “opted out” of OASDI’s combined (employer and employee) 12.4% payroll taxes and are instead participating in a Social Security replacement plan (SSRP).  This article provides a brief introduction to such plans.

In a back-handed way, Section 3121(b)(7)(F) of the Internal Revenue Code states that most individuals’ employee services performed for a State, a political subdivision thereof, or of any instrumentality of a State or a wholly owned political subdivision or instrumentality thereof will be subject to OASDI provided that such individuals are not members of a “retirement system” of such State, political subdivision, or instrumentality.  The term “retirement system” is defined in Section 218(b)(4) of the Social Security Act (Act). These are SSRPs.

So, how does a governmental employer determine whether it must participate in OASDI or if it can opt out by providing some or all of its employees with benefits under a SSRP?

Steps for analyzing OASDI coverage:

  1. If the employee’s position is covered by an agreement under Section 218 of the Act (Section 218 Agreement) and no exclusion applies, the employee is covered. A Section 218 Agreement is a written agreement in which a State or local government voluntarily agrees to participate in Social Security. Note that once a State or local government agency becomes covered by a Section 218 Agreement, it is not permitted to withdraw or cancel its participation.
  2. If the employee’s position is not covered under a Section 218 Agreement and the employee is covered by a SSRP, the employee’s coverage under OASDI is not mandatory – the sponsoring employer can opt out of OASDI.

Based on numerous cases and inquiries involving these issues, we’ve noticed that:

  • Many public agencies do not know whether they and their employees are subject to a Section 218 Agreement. To find out, an agency can contact the State Social Security Administrator for its State. A list of State contacts can be found here.
  • Many agencies do not understand whether their retirement plans satisfy all of the requirements for being SSRPs. There are different requirements for defined contribution SSRPs and defined benefit SSRPs.
  • Many public agencies that use defined contribution SSRPs do not operate or invest them in accordance with applicable IRS guidelines.

In future posts, I’ll address more of the specific problems that can arise with SSRPs.

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