With overall required contribution rates increasing at an alarming rate, most CalPERS employers – particularly those with significant “classic” safety populations – are looking for help to pay for these obligations.
We continue to see tremendous interest about the CalPERS “cost-sharing” process. Here are a couple of thoughts about cost-sharing that would be important to know:
- When we talk about “cost-sharing,” we are referring to a splitting of the employer’s required contribution between the employer and its employees.
- The applicable provision of the California Government Code (and the Public Employees’ Retirement Law) is section 20516.
- Basically, there are two forms of cost-sharing agreements: section 20516(b) agreements, referred to as the Amendment Method here, and section 20516(f) agreements, referred to as the MOU Method here. Because the income tax treatment of affected employees could differ under these two approaches, it is important to understand the differences.
- Amendment Method – Under the Amendment Method, the employer and its affected employee groups must follow the CalPERS prescribed contract amendment procedures to achieve the desired cost-sharing by increasing the employees’ normal member contributions (their mandatory contributions) to CalPERS. The process requires approval by a majority of affected employees by a secret ballot. If this is done (and the process can take 3–6 months), the additional employee contributions will be accounted for as “normal member contributions,” which are vested and refundable to members upon separation. More importantly, if the employer adopts (or already has) an appropriate IRC section 414(h)(2) “pick-up” resolution for these amounts, the contributions can be treated as pre-tax contributions. If, however, there is no pick-up resolution covering these new cost-sharing contributions, they will be treated as after-tax. Employers should carefully review the terms of previously adopted pick-up resolutions if they are relying on them to cover current cost-sharing contributions.
Beginning in 2019, there is greater flexibility for employers who have adopted the Amendment Method to “update” the employees’ cost-sharing percentage, or to have the employees’ cost-sharing automatically change based on an agreed-upon methodology. New legislation allows the parties to implement certain changes with CalPERS without a formal contract amendment.
- MOU Method – Under the MOU Method, the employer and its affected employee groups agree under the terms of an MOU, outside the CalPERS system, to “share” the employer’s required contribution to CalPERS. Here, the parties are not amending the CalPERS contract to change the rate of employees’ mandatory contributions (and no secret ballot is required). They are simply agreeing that the employees’ pay will be reduced and used to pay a portion of the employer’s required contribution.
In many cases, cost-sharing under this method contemplates that the employees’ gross paychecks will reflect a deduction to be applied to the cost-sharing obligation. There is a difference of opinion as to the tax treatment of this deduction. This is because the pick-up rules apply only to normal member contributions. However, cost-sharing contributions through the MOU Method, unlike those under the Amendment Method, are not converted into normal members contributions. Numerous cities have adopted the MOU Method of cost-sharing and have taken the position that the amounts being cost-shared by employees (that is, the deductions) are pre-tax. However, there are a number of California cities and their advisers, including this author, who believe that the employees’ cost-sharing payment must be considered as after-tax.
Given the differing views with respect to the tax treatment of cost-sharing under the MOU Method, employers who contemplate this approach should consult with knowledgeable employee benefits counsel, and may wish to obtain a private letter ruling before they treat 20516(f) cost-sharing amounts as pre-tax.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.