When is a Public Employee a “Qualified Participant” in a Social Security Replacement Plan?

by | Feb 10, 2022 | 401(a), 457(b) Plans, Governmental Benefits, Plan Administration, Record-keeping, Social Security

As previously discussed, a public agency that does not have a section 218 agreement has a choice of participating in Social Security or providing a Social Security Replacement Plan (SSRP). Although many California local governments rely on CalPERS as their principal SSRP, CalPERS generally does not cover part-time, seasonal, or temporary workers. Many cities and local agencies that participate in CalPERS still need to have an SSRP for their part-time, seasonal and temporary workers — sometimes referred to as PTS plans. We also see relatively newer public agencies and JPAs that, for budgetary reasons, have decided not to participate in CalPERS and must provide an SSRP for all full- and part-time employees. In this post, we discuss some of the common misconceptions about being a “qualified participant” in a defined contribution SSRP (DCSSRP).

Apart from the regulations under Internal Revenue Code (Code) section 3121(b)(7), a good explanation of “who is a qualified participant” can be found in the Federal-State Reference Guide (Guide), also referred to as IRS Publication 963. Here are several ways that public agencies can and do misunderstand their SSRPs and participation in those plans:

  • You can’t participate in an SSRP that has not yet been adopted. Although it may be possible to adopt a 401(a) plan on a retroactive basis (that is, sign the plan before the end of the plan year with an effective date as of the first day of the year), this will not work for an SSRP. In order to be a qualified participant, the plan first must be properly adopted and effective.
  • You can’t authorize employee contributions on a retroactive basis. Whether a public agency plans to allow or require employee contributions to a 457(b) plan or a 401(a) plan as part of the SSRP, IRS rules do not allow employee 457(b) contributions or employee mandatory 401(a) contributions prior to the adoption/effective date of the plan. This rule exists independently from the rules allowing limited retroactive establishment of 401(a) plans.
  • Qualified participation is required each and every day. In order to be exempt from Social Security, a participant in a defined contribution SSRP (DCSSRP) each and every day must have satisfied all conditions (other than vesting) to receive at least a 7.5% of compensation allocation to his/her account. If, for example, the 7.5% requirement is being fulfilled by a combination of employee contributions and employer contributions in a 457(b) plan, and the employee temporarily ceases his/her contributions, the exemption from Social Security would be lost for that employee unless the overall level of employee and employer contributions for that individual for the entire year still satisfies the 7.5% requirement. A DCSSRP may provide for participation beginning on the first day of the first full month of employment without violating this rule.
  • A DCSSRP does not have to operate on a payroll-by-payroll basis. Although Social Security and other applicable payroll taxes are taken out on a payroll-by-payroll basis, a DCSSRP does not necessarily have to operate on a payroll-by-payroll basis. Furthermore, employer contributions do not have to be made at the same time as employee contributions. For example, it may be possible to satisfy the overall 7.5% requirement through a combination of 3.75% in employee deferrals made on a payroll-by-payroll basis, along with a once-a-year employer contribution of the remaining 3.75%. For this to work, the plan may not require an employee to be employed on the last day of the plan year (or the date of contribution) in order to receive the employer contribution.

Typically a DCSSRP document will be provided by the recordkeeper for the plan. Because many of the rules and requirements for DCSSRPs are unique to SSRPS, and may or may not apply to regular 457(b) or 401(a) plans, it is critical for the employer and its recordkeeper to be on the same page when the employer intends to use its 457(b) or 401(a) plan as a DCSSRP.

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 jeff.chang@bbklaw.com or (916) 329-3685.

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