By Jeff Chang
The vast majority of public agencies already maintain a 457(b), or eligible deferred compensation plan. A much smaller number also maintains one or more 401(a) plans in addition. This post discusses some of the reasons a public agency might want to add a 401(a) plan to its employee benefits lineup.
For purposes of this post, and my blog in general, the term “401(a) plan” is used to refer to a tax-qualified defined contribution plan (i.e., a money purchase pension plan or a discretionary contribution plan). Technically, the term “401(a)” refers to the various requirements for tax-qualified retirement plans under the Internal Revenue Code and, could therefore, refer to both defined benefit pension plans (like CalPERS) as well as defined contribution plans. However, in keeping with the terminology used by many public sector recordkeepers, investment consultants, HR staff and finance staff, we are using the term to refer to tax-qualified defined contribution plans.
Although there may be many more less obvious reasons for adding a 401(a) plan, here are the ones we normally consider:
- Preserving the 457(b) “deferral” limit for employee contributions. As we’ve preciously written, the so-called deferral limit for governmental 457(b) plans is a “combined” limit, which applies to all employee pre-tax deferrals and all employer nonelective contributions made to a participant’s account. The current annual limit (for 2021) is $19,500 for participants under the age of 50 and those not using certain special “unused contribution” rules. This basic limit is increased by $6,500 for those participants who are 50 or older; this is the age-50 catch-up rule. Many employees may wish to utilize the full deferral limit to reduce their taxable income. Due to the application of the combined limit, any employer matching or other nonelective contributions will reduce/limit the employees’ maximum deferral. Public agencies which make, or plan to make, some form of employer contribution can avoid the potential conflict with employees’ tax planning by making the matching contribution (which still can be based on 457 plan deferrals) or other employer contributions to a separate 401(a) plan. Generally speaking, a separate 401(a) can receive an annual employer contribution of up to $58,000 per employee. This limit is separate from the $19,500/$6,500 limits mentioned above.
- Establishing a 401(a) for a special purpose. A public agency employer may decide to establish a separate 401(a) plan to address a particular benefits need or objective. Two such needs immediately come to mind. First, an agency may wish to use a separate 401(a) plan as its Social Security replacement plan. As we’ve previously discussed, the replacement plan rules must be met at all times, or the employer may have to make FICA contributions for the affected employees. Because many public employers participate in CalPERS, a replacement plan may only be needed for the part-time, temporary, and seasonal employees who would not automatically be CalPERS eligible. Second, a significant number of California public agencies have decided to provide so-called PEPRA “make-whole” plans – these are plans designed to mitigate and make-up for the differing (lesser) benefit that PEPRA employees receive from CalPERS (or any other public defined benefit plan) when compared to “classic” employees.
- Establishing a 401(a) for a special group or classification. Many public agencies bargain with a number of labor unions and may have agreed to make specified levels of employer contributions for each group. Many cities and special districts also enter into employment contracts for high-level executives and managers that provide for additional employer retirement contributions for these individuals. Because it may not be desirable to include and “share” the terms of all of these arrangements in a single plan document, many such agencies create separate 401(a) plans for some or all of these groups or individuals. That way, one bargaining party is not necessarily a party to another party’s plan. If a 401(a) is used for this purpose, it is important to keep it “in sync” with the terms of the applicable MOU or employment contract.
It goes without saying that there are pros and cons to establishing and maintaining multiple retirement plans. If a public agency decides to establish one or more separate 401(a) plans, it is critical for the agency to keep track of all of the plan documents and plan amendments for each and every one of its plans so that everyone involved with the plans can keep track of them and keep them separate and compliant.
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.