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Many government employees qualify for a special type of retirement plan known as a 414(h) plan. These plans offer tax-deferred contributions and the opportunity for lower taxable income. Here’s what you need to know about 414(h) plans and how they work.
What is a 414(h) plan?
A 414(h) plan, also called a pick-up plan, is an employer-sponsored retirement account available to public employees who work for the federal, state, or local government.
Employees and employers can contribute to a 414(h) plan, in which employees contribute a fixed dollar amount or a percentage of their income, as determined by the employer. The employee contributions are then “levied” by the employer, excluding them from the employee’s gross income for that year. Because the contribution is not counted as income, employees can avoid the 7.65 percent payroll tax for Social Security and Medicare. This tax benefit is an important difference from 401(k) plans.
Contributions to a 414(h) plan can be deferred until withdrawn at retirement, defined as after age 59 ½. Withdrawals are then taxed as income at normal income tax rates.
Employee contributions are automatically fully allocated, meaning employees can withdraw all the money in the account if they decide to leave. A 414(h) plan also has no income restrictions, meaning any qualified employee can participate regardless of income, unlike IRAs.
To comply with IRS regulations, employers must certify that they will contribute the employee’s money directly to the plan. Furthermore, employees cannot choose to receive the money instead of the pension contribution, or opt out of the ‘pick-up’.
When can you withdraw money from a 414(h) plan?
Once the employee reaches the age of 59.5, he can withdraw money from the scheme without penalty. Required minimum distributions (RMDs) also begin once the account holder reaches age 73. Account holders can withdraw funds before age 59 ½, but they are subject to income taxes, plus a 10 percent penalty. However, they can withdraw money without penalty for certain reasons, such as unreimbursed medical expenses that exceed 10 percent of their adjusted gross income, if they are military reservists called to active duty, or if they retire after age a government or public position. 55 (or 50 for certain professions). The tax authorities have a comprehensive list of qualifying circumstances.
What are the benefits of a 414(h) plan?
414(h) plans have a number of benefits.
- No income limit: Unlike some retirement plans, a 414(h) has no income restrictions that prohibit employees from participating if they earn too much.
- Pre-tax contributions: Employees’ taxable income is reduced because the money is deducted directly from a pre-tax paycheck, reducing not only income taxes but also payroll taxes for Social Security and Medicare.
- Tax-deferred growth: The money in a 414(h) retirement account grows without any immediate tax liability. Money is only taxed when it is withdrawn from the account.
- Contributions are awarded automatically: In a 414(h) plan, contributions are made automatically, meaning account holders don’t have to wait for contributions – including employer contributions – to be theirs.
What are the disadvantages of a 414(h) plan?
While there are many advantages to having a 414(h) plan, there are also some disadvantages:
- Penalties for early withdrawal: A 414(h) carries significant costs if you need to withdraw your money before retirement age. Not only will you owe income tax on the withdrawal, but you will also incur a 10 percent bonus penalty.
- Are not eligible for the savings credit: A 414(h) plan is not eligible for the Saver’s Tax Credit, also known as the Retirement Savings Contributions Credit. That tax credit is intended to encourage low- and moderate-income taxpayers to save for retirement.
- Less flexibility regarding contributions: Because employers determine the contribution amount, savers may have less flexibility and control compared to other retirement plans, such as an IRA or 401(k), where the account holder can contribute as much or as little as they want, up to annual limits. .
How much can you contribute?
The employer determines the amount that can be contributed each year, which may be a specific dollar amount or a percentage of the employee’s salary. The employer pays the employee’s contributions directly into the scheme. To ensure that the 414(h) plan meets IRS standards, the employer cannot allow employees to opt out of the “pickup” or receive the contributions directly.
What are the tax implications of a 414(h) plan?
If a 414(h) plan is set up properly, employee contributions are treated as employer contributions and excluded from gross income for the year, meaning the employee’s taxable income is reduced. In addition, the contributions are exempt from Social Security and Medicare taxes, also known as FICA. Like many retirement accounts, the money in a 414(h) is deferred.
Withdrawals are subject to federal and state ordinary income taxes and are also generally subject to a 10 percent early withdrawal penalty.
Are contributions to a 414(h) plan tax deductible?
Although the contributions are made pre-tax, they are not tax deductible because they do not count as gross income on an employee’s tax return. The savings discount also does not apply.
What happens if you leave your job?
If you change jobs, you can leave your money in the 414(h) plan or move it to a qualified plan from a new employer or an IRA with rollover. If you choose the rollover option, you have two options:
- In one direct changeoverrequest that the assets in your 414(h) retirement account be transferred to another retirement plan.
- In one indirect coveryou withdraw the money from the account and deposit it into another retirement account. If you choose this option, you have 60 days to complete the transfer. Otherwise, you will pay a 10 percent early withdrawal penalty on top of income tax for the amount.
In short
A 414(h) plan is an employer-sponsored account for government employees that offers tax benefits and is intended to help individuals save for retirement. Although the plan offers several benefits, it is important to consider the tradeoffs and tax implications before deciding whether it is the right retirement savings plan for you. If you’re unsure about your retirement plan, speaking with a financial advisor can be a smart first step.
