In an earlier post, we explained what “pick-up” contributions are, and how they are used by many governmental employers to convert mandatory after-tax employee contributions into pre-tax contributions.
IRS Revenue Ruling 2006-43 contains specific guidance on what the IRS requires in the way of documentation in order for there to be a “pick-up” in accordance with Internal Revenue Code section 414(h)(2). These requirements go to:
- The nature of the “formal action” that needs to be taken. Based on the Ruling, a resolution of the governing body or the adoption by the governing body of legislation or an ordinance would clearly suffice.
- The formal action and documentation must include certain “magic language,” reflecting an intention by the employer to “convert” employee contributions (which are normally after-tax) into pre-tax employer contributions.
- The formal action can only be prospective.
- The formal action also should include language prohibiting employee from opting-out of the pick-up or from receiving the contributed amounts instead of having them paid into the plan.
Based on recent discussions we have had with several municipalities about pre-tax and after-tax employee contributions, it became apparent that a few additional points of clarification about pick-ups were in order:
- An MOU provision that provides for pre-tax employee mandatory contributions to a pension plan (such as CalPERS) will most likely not satisfy the documentation requirements for a pick-up.
- Although a city may have entered into a contract amendment with CalPERS to provide for certain explicit cost-sharing of employer contributions through increased employee mandatory contributions, the contract amendment by itself is not enough to document a “pick-up.”
- Many governmental employers have adopted money purchase pension plans, which provide for certain levels of employee mandatory contributions, and which allow the employer to check a box confirming that: “The Employer hereby elects to “pick-up” the Mandatory/Required Participant Contribution.” Based on the IRS guidance discussed above, this “check the box” approach arguably also does not satisfy the pick-up documentation requirements.
- A properly adopted pick-up resolution that is adopted now, cannot have retroactive effect – that is, previous employee contributions that were not properly picked-up should have been treated as after-tax.
If your agency is treating various amounts of employee mandatory contributions as pre-tax, it is important for you to review each and every instance where this practice commenced, as well as when levels of pre-tax contributions were changed, to make sure that your agency has proper documentation to justify its “pick-up” of these amounts.
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.