OPTIONS AVAILABLE TO
MANDATORY SOCIAL SECURITY
By DAVE ZAHLLER, Illinois State Director, Public Employees Benefit Services Corporation (PEBSCO)
Based on new federal regulations promulgated
from OBRA of 1990, it appears that in Illinois, there are
three different programs that may satisfy the "retirement system" requirement that municipal employers
must now meet if they are not covered under social
security.
(1) The Illinois Municipal Retirement Fund
(IMRF) (which requires mandatory participation in social security);
(2) A Section 401 (a) Qualified Retirement Plan; or
(3) A Section 457 Deferred Compensation Plan.
Section 401 (a) and 457 plans do not require participation in social security. In broad terms, a "retirement
system" can either be a defined benefit or defined
contribution plan.
Defined Benefit Plans
A defined benefit plan provides predetermined retirement benefits. Benefits are usually calculated by a
formula in the plan, normally based on a percentage
factor applied to the employee's length of service and
final average compensation. Should a defined benefit
plan be used to satisfy the minimum requirement, the
regulations appear to indicate that accrued benefits
under the plan would have to be comparable to the
benefits the employee would have received had the
employer been subject to social security.
Defined Contribution Plans
Benefits from a defined contribution plan are based
on factors (if applicable) such as contributions, investment gains, plan administration expenses, forfeitures,
the distribution mode selected by the participant, and
length of service. In a defined contribution plan, the
regulations appear to indicate that the minimum requirement for contribution is 7.5% of an employee's
annual compensation.
IMRF is a defined benefit plan which requires compulsory participation in social security. A Section 401 (a)
plan can be established as either a defined benefit or a
defined contribution plan. A Section 457 is always a
defined contribution plan.
The Illinois Municipal Retirement Fund (IMRF)
In IMRF, the employee pays 4.5% of gross income
into the plan. In addition, the employer pays an actuarially determined percentage as a contribution into each
employee's IMRF pension. Under this plan, social security payments are mandatory, with 7.65% paid by the
employee and matched by the employer.
Municipal employers have tax levy authority to pay
for the costs associated with IMRF and social security.
401 (a) Qualified Retirement Plan
In a 401 (a) plan, a defined contribution system is
called a Money Purchase Pension Plan. It has fixed
contributions that are allocated to the employee's account. The value of employee accounts is often much
greater than the sum contributed over the years. Individual Directed Accounts (IDA's) can be set up that
allow employees to control investments of plan assets.
Upon retirement, the account often is converted into an
annuity that provides pension benefits. Contributions
and investment returns are allocated to an individual
account for each employee. Benefits are based on the
amount in the account which is distributed at retirement or upon disability, death or termination of employment. Investments and earnings on the funds are
not subject to income tax until the funds are distributed
to the employees.
Section 457 Plans
Section 457 plans allow for voluntary contributions
by employees who are deferring income. Employees
may determine a portion of salary and tax dollars to
save for retirement. The definition of "retirement system" in the new regulations makes it clear that a 457
plan meets the requirements of the law if it is mandatory, and has a minimum level of contributions equal to
7.5% of salary (the legal minimum).
Differences between 401 (a) s and 457s
In the 401 (a) plan, the total annual amount contributed to each employee's account cannot exceed the
lesser of 25% of covered compensation or $30, 000. 457
plans allow for contribution of up to 33 1/3% of includ-
June 1991 / Illinois Municipal Review / Page 9
ible income (usually 25% of gross). In either case, once
the minimum requirement of 7.5% is met, the employee
may elect to defer an additional amount to the legal
maximum contribution levels of each. Should the
401 (a) allow for voluntary contributions, these are
made with after-tax dollars. Only the Section 457 plan
allows for the voluntary additional contributions to be
made with pre-tax dollars.
Employer Level Costs
There are only incidental costs of payroll deduction
for a Section 457 plan, while the 401 (a) plan generally
will require initial set up fees and annual administrative
costs.
Distribution
Both plans allow for employee access to the funds at
any age in the event of termination of employment.
Both plans allow an employee to postpone receipt of
benefits until 60 days after reaching the age of 701/2. A
401 (a) plan allows for a rollover to an IRA or other
qualified retirement plans, while a 457 plan allows for
transfer only to another 457 plan. Distributions are taxable in the year of receipt except to the extent that
contributions are made with pre-tax dollars. Many employees choose to take the payments over several years.
457 plan distributions are exempt from state income tax
in Illinois.
Loans
The qualified 401 (a) plan may allow loans to participants while employed while a 457 plan participant only
has access to the funds while employed in case of an
"unforeseeable emergency."
Vesting
Employer contributions to a 401 (a) plan in excess of
the amount necessary to satisfy the requirements may
vest on one of two schedules: 1) 100% after 5 years of
service or 2) 20% after 3 years increasing by 20% after
each year, with 100% vesting after 7 years. In a 457 plan
both the employer and voluntary employee contributions are vested 100% immediately.
Investment Alternatives
Many funding vehicles are acceptable in a 457 plan.
Those most commonly used include annuity contracts,
mutual funds, or life insurance. All assets remain the
property of the employer. A 401 (a) plan may include the same types of funding vehicles as a 457 plan, but
must be held in or through a trust.
Summary
In appears that only the Sections 401 (a) and 457
plans (if they are mandatory for all employees not
covered by social security) are alternatives to social
security under OBRA in Illinois for public sector employers. The 457 plans typically do not require annual
administrative fees, but do allow 7 for immediate vesting, employee control of investments, and voluntary
contributions to be made with pre-tax dollars.
The purpose of this article is not to recommend a
particular option but to outline what options are available. Each Illinois municipality currently without a retirement system may have a specific reason to select
one option over another.
For additional information about IMRF, contact:
Illinois Municipal Retirement Fund, 100 S. Wacker Dr.,
Chicago, IL 60606, 312/346-6722.
For additional information about 457 and 401 (a)
plans, please contact: Public Employees Benefit Services Corporation (PEBSCO), Dave Zahller, State Director, 1202 75th St., Suite 3, Downers Grove, IL 60516,
708/969-3300.
The preceding article, written by Dave Zahller of
PEBSCO is published with the understanding that the
author is not engaged in rendering legal advice. If legal
advice is required, the services of your organization's
legal counsel should be sought. •
ABOUT THE AUTHOR
Dave Zahller is the Illinois State Director of Public Employee Benefit
Services Corporation (PEBSCO), the 457 plan administrator for the
United States Conference of Mayors (USCM) and the National Association of Counties (NaCo) Deferred Compensation plans. PEBSCO
administers plans for over 3, 000 jurisdictions nationwide with over
380, 000 participants. In Illinois, PEBSCO administers plans for over
125 public employers with over 25, 000 participants.
Page 10 / Illinois Municipal Review / June 1991