It is estimated that, out of 131.7 million full-time employees in the United States, some 22.6 million are government employees. It is, though, difficult to estimate the number of employees in the public sector since, besides the federal, state, and local levels of government, some federal and state agencies, as well as tax-exempt organizations, may or may not be included.

What matters is that retirement planning is different if your career has been as a government employee.

Retirement plans established for the benefit of governmental employees generally function in ways similar to those covering private employers. However, in many cases, different Sections of the Internal Revenue Code determine the tax treatment of these plans.

Depending on the statutory basis for the plan and how it operates, employer and employee contributions may be subject to Federal income tax at the time of contribution, or tax-deferred until distributed; and they may be taxable or excluded from social security and Medicare taxes (FICA).

Public Retirement Systems (FICA Replacement Plans)

Effective July 2, 1991, Congress made social security coverage mandatory for state and local government employees who are neither covered by a Section 218 Agreement nor qualifying participants in a public retirement system.

A Section 218 Agreement is a voluntary agreement between the State and the Social Security Administration (SSA) to provide Social Security and Medicare Hospital Insurance (HI) or Medicare HI-only coverage for State and local government employees.

A public retirement system is any retirement system established by the United States, a state, territory, or possession of the United States, or their political subdivisions.

The Federal Employees Retirement System, or FERS, is the retirement plan for all U.S. civilian employees.

If you are an older civilian service employee of the federal government who was hired before 1987, you may have been grandfathered into the Civil Service Retirement System (CSRS), which provides retirement, disability, and survivor benefits.

Because you haven’t had Social Security taxes deducted from your paycheck, you won’t be eligible to receive Social Security benefits unless you’ve earned them through another job or qualify through your spouse. If you do qualify for Social Security, your CSRS pension may reduce your benefits.

If you are a civilian service employee who was hired in 1987 or later, you are covered by FERS. It provides Social Security benefits, a basic benefit plan (pension), and a thrift savings plan (TSP) that consists of automatic government contributions, voluntary employee contributions, and matching government contributions.

The retirement benefits you’ll receive from these plans are structured as annuities based on your age, years of service, and plan contributions.

States can provide these mandatorily covered employees with membership in a public retirement system as an alternative to mandatory social security coverage. Some states have retirement systems specifically for state agencies, public education, city governments, and county governments (for instance, the Teacher Retirement System for university and school district employees.)

Employees may also be covered by both a public retirement system and social security under a Section 218 Agreement.

A governmental retirement plan must meet certain minimum benefit or contribution standards to qualify as a public retirement system, and thereby serve as a “replacement” plan exempting the participants from mandatory social security coverage.

These standards are based solely on meeting a minimum benefit level provided (defined benefit plan), or a minimum amount contributed (defined contribution plan) to the participant.

Types of Public Employer Plans

The following types of retirement plans are included here (Sections refer to the Internal Revenue Code).

• Section 401(a) - Qualified Plan;
  
  
• Section 403(b) – Annuity for public schools and 501(c)(3) organizations (tax exempt commonly referred to as charitable organizations);
  
  
• Section 457(b) – Nonqualified, eligible deferred compensation plans for state and local governments and tax-exempt organizations;
  
  
• Section 457(f) – Nonqualified, ineligible deferred compensation plans.

After May 6, 1986, state and local governments are not eligible to adopt Section 401(k) plans except for rural cooperatives and Indian tribal entities. Under grandfather provisions, plans established prior to that date may continue to operate and add new participants.

Almost all governmental plans are covered under one of these Sections.

Section 401(a) Qualified Plans

Generally, any public employer may set up a 401(a) plan. Under this plan, employer contributions not made pursuant to a salary reduction agreement, but including employer “pick-up” contributions (made by the employer on behalf of the participant), are deferred from income tax until distribution, and exempt from social security and Medicare tax.

Employer contributions made under a salary reduction agreement are deferred from income tax, but are subject to FICA tax.

Employee contributions pursuant to a salary reduction agreement are subject to income tax and FICA tax.

Section 403(b) Plans

Plans under IRC Section 403(b), also called tax-sheltered annuities, are available to certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.

To maintain a Section 403(b) plan, a governmental employer must be a public school of a state, political subdivision of a state, or an agency or instrumentality of one or more of these.

Many public school employees are covered by 403(b) plans in addition to social security coverage under Section 218.

403(b) plans resemble “qualified” (i.e., 401(k)) plans in many respects. Eligible participants may defer amounts from income tax up to an annual limit ($19,000 in 2019). This amount may be increased for certain employees with more than 15 years of service. In addition, additional tax-deferred “catch-up” contributions may be made to employees age 50 or older.

Employer contributions (within dollar limitations) are tax-deferred and exempt from FICA.

Employee elective contributions to 403(b) plans that are considered employer contributions pursuant to a salary reduction agreement are deferred from income tax, but taxable for FICA.

Section 457(b) Plans

Section 457 addresses nonqualified plans. Many public employees participate in nonqualified, or Section 457, plans. These plans can be established by state and local governments or tax-exempt organizations. If they meet the requirements of IRC Section 457(b), they are considered “eligible” plans; if not they are considered “ineligible” and are governed by IRC Section 457(f).

Governmental 457(b) plans must be funded, with assets held in trust for the benefit of employees. Plan assets and income of all other eligible plans must remain the property of the employer.

Plans eligible under 457(b) may defer amounts from income tax up to an annual limit ($19,000 in 2019). In addition, “catch-up” contributions may be made to employees age 50 or older.

Social security and Medicare taxes generally apply to all employer and employee contributions.

Employer contributions to 457(b) plans are tax deferred up to annual limits.

Employee elective contributions are deferred from income tax. They are subject to FICA.

Section 457(f) Plans

Nonqualified state or local government plans that do not meet the tests of 457(b) are ineligible, or 457(f), plans. There is no limit on the annual deferrals on these plans, but to defer taxation all amounts must be subject to substantial risk of forfeiture.

The rights of a person to compensation are subject to substantial risk of forfeiture if such person's rights to such compensation are conditioned upon the future performance of substantial services by any individual.

A substantial risk of forfeiture exists where rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person, or the occurrence of a condition related to a purpose of the transfer, and the possibility of forfeiture is substantial if such condition is not satisfied.

Distributions are generally subject to social security and Medicare taxes at the later of the time:

Employer contributions to 457(f) plans are includible in income in the year they are no longer subject to any substantial risk of forfeiture. They are subject to income tax withholding in the year they are actually or constructively paid.

457(f) contributions are subject to FICA at the later of:

1. When the services are performed, or

2. When there is no substantial risk of forfeiture and when the amounts are reasonably ascertainable.

Governmental retirement plans are complex and must satisfy federal laws as well as pension, investment, and other laws of the applicable state or local governments.

All states have enacted major changes to their public pension systems to reduce costs in recent years. Among the most frequent reforms are reduced benefit levels, longer vesting periods, increased age and service requirements, limited cost-of-living adjustments, and increased employer and employee contributions.

You should get professional help to find out what are the benefits of your pension plan and whether you need additional funding for your “golden”years.