FICA Replacement Plans for Public Employers
Governmental employers that employ part-time, seasonal and/or temporary employees may want to consider adopting a FICA Replacement Plan. By implementing a FICA Replacement Plan, an eligible government employer may eliminate all or a portion of the employer share of FICA tax (6.2% of Social Security wages) for the employees participating in the plan. The determination of which employees, if any, are eligible to be covered by a FICA Replacement Plan requires some due diligence, but the end result may make the analysis economically worthwhile.
Brief and Incomplete History Lesson
When the Social Security Act was first adopted, employees of public employers were not permitted to participate in Social Security. In the early 1950s Section 218 was added to the Social Security Act permitting states, and indirectly their political subdivisions (e.g. towns and cities), to enroll their employees voluntarily in Social Security by entering into a “Section 218 Agreement” with the Social Security Administration. Under Section 218 a state enters into a master Section 218 Agreement with the Social Security Administration and the state’s political subdivisions may then enter into Section 218 Agreements with the state. Certain employees can be excluded from voluntary coverage under a Section 218 Agreement including employees covered by a retirement system, part-time employees, temporary employees and seasonal employees. It should be noted, that Section 218 Agreements contain similar but not necessarily uniform terms and the classes of employees excluded from voluntary Social Security coverage may vary among public employers.
Since July 1991 Social Security coverage has been mandated for all governmental employees excluded from voluntary Social Security coverage under a Section 218 Agreement who are not participating in a qualified retirement system (referred to in this article as a “FICA Replacement Plan”). Mandatory Social Security coverage for a class of employees can stop when the employees become participants in a FICA Replacement Plan.
Characteristics of a Defined Contribution FICA Replacement Plan
A qualified retirement system can be either a defined benefit plan or a defined contribution plan that meets certain requirements under Internal Revenue Code Section 3121 and Treasury Reg Section 31.3121(b)(7)-2. The FICA Replacement Plan that is the focus of this article is a defined contribution employee funded individual account arrangement that has the following characteristics:
- The employee must satisfy all conditions in the bullets below (other than vesting) for receiving an allocation to his or her account (exclusive of earnings) that meets the minimum retirement benefit requirement for the period of coverage;
- The eligible employees must not be in a class of employees voluntarily covered by Social Security under a Section 218 agreement (these employees can participate in a retirement system, but that is in addition to participation in Social Security);
- The allocations to the participant’s account under the plan must be equal to 7.5% of the participant’s compensation for the coverage period. The contribution can be through mandatory employee salary deferral only.
- The definition of compensation used to determine allocations must generally be no less inclusive than the definition of the employee's base salary. Overtime pay, bonuses, and other taxable payments or benefits can be excluded from the definition of compensation.
- The participant’s account must earn a reasonable rate of interest.
- Participants who are part-time, seasonal or temporary employees must be 100% vested (exception to first bullet).
In designing FICA Replacement Plans it should be noted that the definition of part-time for purposes of exclusion from voluntary Social Security coverage and the definition of part-time for purposes of the 100% vesting requirement are not the same.