Governmental Employee Benefits

A governmental retirement plan provides pension or other deferred compensation benefits to the employees of the state or local government, including any of their subdivisions, agencies or instrumentalities. In contrast, a non-governmental retirement plan provides benefits to the employees of a private employer, including most tax-exempt entities.

Governmental retirement plans in California are subject to California statutory law, mostly under the Government Code, as well as certain federal and state tax requirements that apply to plans that are intended to provide tax-favored benefits.

No. Governmental plans are exempt from the requirements of ERISA, although many of the ERISA requirements (e.g., responsibilities of plan fiduciaries) have been incorporated into California statutory law and thus made applicable to California-based governmental plans.

Several plans are sponsored either by the state or another governmental entity within California. The largest of such plans is the California Public Employees’ Retirement System (CalPERS), which provides both retirement and welfare benefits to various categories of employees, including both safety (e.g., police and fire) and miscellaneous employees of the state and those local governmental entities, such as cities, counties and special districts, that enter into a contract for CalPERS to provide such benefits.

Other state or local government sponsored plans include (among others): the State Teachers’ Retirement System (CalSTRS), which provides retirement and certain other benefits to primary, secondary, community college and adult education school teachers within the state; the University of California Retirement System; various county retirement systems established under the County Employees Retirement Law of 1937; and systems established under the Legislators’ Retirement Law and the Judges’ Retirement Law.

Most California state employees are required to participate in the applicable state retirement system. However, local government entities, such as cities, counties, commissions and special districts, can elect to participate either in the applicable state retirement system (generally, CalPERS) or in an individual system that is established specifically for such entity. In addition, if certain requirements are met, a local governmental entity can participate in both the state system and an individually-sponsored plan.

CalPERS and the other government-sponsored retirement systems generally provide a well-defined system that can work well as an agency’s primary retirement plan for all of its eligible employees. In addition, most of the administrative duties and obligations involved with maintaining a retirement plan are managed and overseen by CalPERS.
On the other hand, our experience is that a governmental employer will generally come out ahead both in terms of benefit flexibility and employer cost by adopting its own properly designed plan. This is especially true in cases where the employer wants to provide supplemental benefits to a particular group of employees, such as those who are nearing retirement age.

Governmental employers can maintain tax-qualified plans of two basic types outside of CalPERS, either as a supplement to or a replacement for CalPERS. First, a defined benefit pension plan provides a stated benefit for employees upon retirement, usually based on a percentage of compensation multiplied by the number of years of employment. A defined contribution plan generally provides that the employer will contribute a stated percentage of employees’ compensation to the plan during their years of employment, and the employees’ benefit will be whatever those contributions and earnings add up to when the employees retire.
In addition, a governmental employer can establish a 457(b) plan, with public schools also able to adopt a 403(b) tax-sheltered annuity program.

Yes. In general, qualified governmental plans are subject to the tax qualification rules that existed prior to the enactment of ERISA. Therefore, many of ERISA’s and subsequent legislation’s tax-qualification requirements, including a prohibition on discrimination in favor of highly compensated employees, accelerated vesting, etc., do not apply to governmental plans. This fact makes such plans an ideal vehicle for providing either a broad-based plan for all employees or enhanced benefits for targeted employees or groups of employees with maximum flexibility in plan design and a minimum of cost.

California governmental employers are prohibited from impairing the contract rights of public employees to their retirement and certain other benefits. The California Supreme Court and other courts in California, as well as the applicable state agencies, have interpreted this constitutional requirement as prohibiting a governmental employer, in most cases, from reducing or eliminating the most valuable benefit that is offered at any time during an employee’s public employment. However, the full impact of this requirement can be avoided, and a governmental entity’s flexibility to amend or terminate its benefits can be preserved, if certain legal steps are taken as early as possible.

With the exception of a few special and grandfathered situations, governmental employers cannot sponsor 401(k) plans. However, governmental employers and their employees can enjoy similar benefit rights through adoption of a properly designed 457(b), or a 403(b) arrangement (schools only).

Section 457 of the Internal Revenue Code provides the requirements that apply to virtually all non-tax-qualified deferred compensation plans that are adopted by governmental entities. If such an entity adopts an “eligible deferred compensation plan” under section 457(b), and its requirements are met, then amounts deferred under the plan and accumulated net income will not be taxed until the particular employee terminates employment and actually receives a distribution of such amounts.

The maximum annual amount that can be deferred under such a plan either by or for any employee is $18,000 for 2017, $18,500 for 2018, or 100% of the employee’s compensation. Such amount may be increased for inflation by the IRS, in $500 increments. In addition, catch-up contributions can be made either during the last three years prior to attaining normal retirement age under the plan or after attainment of age 50.
Also, section 457(b) imposes limits on the circumstances in which benefits can be paid to employees, such as upon employment termination or in the event of an unforeseeable emergency, and all plan assets must be held “in trust” for the exclusive benefit of the plan’s participants and beneficiaries.

Most governmental 457(b) plans are designed to permit participants to direct the investment of their accounts. This right must be spelled out in the plan documents.

In general, the trustee and named fiduciaries of the plan are legally responsible for the prudent investment of all plan assets. In the case of a participant-directed 457(b) plan, maintained by a California public agency, these individuals or entities may be relieved of their fiduciary duties for plan investments if the agency complies with the rules described in ERISA section 404(c), even though ERISA is not applicable to the plan.