Although most public employers are familiar with the concept of a “pick-up” of employee mandatory contributions, many do not appreciate what is required to properly document a “pick-up”. This post reviews the basics of employer pick-ups and the documentation requirements that go along with them.
What is an employer “pick-up contribution”? As we’ve previously discussed, most governmental employers are not eligible to establish or maintain a 401(k) plan. As a result, employee contributions to most governmental 401(a) plans – as opposed to 457(b) plans (which may receive employee pre-tax deferrals) – generally will be made on an after-tax basis. One way that a governmental plan sponsor can change the tax treatment of such employee after-tax contributions (to make them pre-tax) is to “pick them up” in accordance with Internal Revenue Code section 414(h)(2) and applicable IRS guidance.
Perhaps the most confusing aspect of picked up contributions is who is actually making the contribution. The answer is: it depends. Although a properly picked-up contribution is “treated” as though it has been made by the employer for income tax purposes, it may come out of the employee’s pay (an employee-paid pick-up contribution) or the employer may decide to make the picked-up contribution in addition to any other employer contributions it may already be making (an employer-paid pick-up contribution). It is important to distinguish between employee-paid and employer-paid pick-ups because some parties may not appreciate the difference. As mentioned below, the distinction may also affect the payroll tax treatment of these amounts.
Documentation of Pick-ups. It is important to understand that the documentation requirements for pick-ups changed at the beginning of 2009. Generally, from that date forward, in order for certain employee contributions to be picked-up under section 414(h)(2):
- The employer must take formal action, which is memorialized in a contemporaneous writing (e.g., meeting minutes, a resolution, or an ordinance) specifying that the contributions, although designated as employee contributions, are being picked-up by the employer.
- The designation of the contribution amounts (along with the class of employees affected) must be prospective (retroactive pick-ups are not allowed).
- From and after the date of the pick-up, affected employees may not be allowed to have a cash or deferred election right (that is, the ability to opt out of the pick-up or to receive the contributed amounts directly).
Final Thoughts. Often times a governmental employer will authorize the pick-up of certain employee contributions (e.g., employee mandatory contributions to CalPERS or another defined benefit plan), but fail to extend that authorization to new or later additional employee contributions not mentioned in the initial pick-up authorization. For example, this could occur in connection with new or additional employee contributions under PEPRA. Some governmental employers that have been treating certain employee contributions as picked-up are now realizing that they do not satisfy the documentation requirements for these pick-ups. These employers may need to take immediate action to correct the tax treatment of the amounts that were not properly picked-up and to authorize the intended pick-ups going forward. Finally, because employee-paid pick-ups are subject to employment taxes (such as, Social Security and Medicare, if applicable), while employer-paid pick-ups are not, it is important to keep track of which type of pick-up you are administering.
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 email@example.com or (916) 329-3685.