A 401(k) is the most common type of employer-sponsored retirement plan, but certain employees may have access to a 414(h) plan instead. A 414(h) plan, also called a pick-up plan, offers people who hold government jobs a tax-advantaged way to grow their savings for retirement. If you work for a local, state or federal government agency, you may receive one of these plans as part of your benefits package.
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What Is a 414(h) Plan?
A 414(h) plan isn’t that different from a 401(k) or other employer-sponsored plans in terms of how withdrawals are treated for tax purposes. The key difference is in the categorization of contributions.
Both employees and employers make contributions to the plan. Employers determine the allowable contribution amount for the year; employee contributions may be mandatory. Contributions may be a specific dollar amount or a percentage of an employee’s income. The employer then “picks up” pre-tax employee contributions for tax reporting purposes. This allows those contributions to be excluded from employees’ gross income for the year. Your taxable income for the year would automatically be reduced by the amount that your employer picked up.
For employee contributions to be considered “picked up,” the IRS requires them to meet two rules:
Employers must specify that they’re paying employee contributions directly into the plan.
Participating employees must not be permitted to opt-out of the “pick-up,” or to receive the contributed amounts directly instead of having them paid by the employing unit to the plan.
One potential advantage of a 414(h) plan is that employee contributions may not be subject to FICA taxes. With a 401(k), employee contributions dodge income taxes but are still subject to FICA taxes amounting to 7.65%. Because contributions to a 414(h) are “picked up” and characterized as employer contributions, the employee may be able to avoid these taxes on the contributed amount – provided the plan meets certain IRS criteria.
Pick-up plans are only a retirement savings option for government employees. Depending on your employer, participation may be required as a condition of employment. Unlike an IRA, there are no income restrictions on who can participate in a 414(h) plan or enjoy their tax benefits.
Tax Treatment of 414(h) Plan Withdrawals
Any contributions – either those from an employer or pre-tax employee contributions – can grow without taxes in a 414(h) plan. This means that qualified withdrawals are subject to ordinary income tax when employees begin taking distributions.
Similar to a traditional 401(k) or IRA, 414(h) plans are subject to required minimum distribution rules. Starting January 1, 2023, you must begin taking RMDs at age 73 or face a tax penalty. The current tax penalty for failing to take RMDs is 50% of your withdrawal amount.
Depending on state tax laws, you may also owe state income tax on qualified 414(h) plan distributions. Early withdrawal penalties also apply when you take 414(h) distributions before age 59.5. That means you’d incur ordinary income tax on an early withdrawal, along with a 10% tax penalty.
This penalty also applies if you’re rolling your assets over to another qualified retirement account. The IRS specifies that you must complete any rollovers within 60 days to avoid this penalty. If you’re worried about triggering the 10% tax penalty, the easiest and best way to avoid it is by requesting a direct rollover from one plan to another.
The good news is that contributions to a 414(h) plan are automatically fully vested. If you leave your employer for any reason and decide to roll your plan over, you’d be able to take all of the money in your account with you. With a 401(k), your contributions would be fully vested, but you may have to wait several years for employer-matched contributions to become 100% vested.
Pros and Cons of 414(h) Plans
From a tax perspective, contributing to a 414(h) plan can make your tax filing easier. You don’t have to report your contributions to the plan on your tax return; your employer handles that on their return. All you have to do is enter in your taxable income for the year, as listed on your W-2.
Any taxable income reductions from 414(h) plan contributions can work to your advantage if you’re in a higher income range. The more you earn, the higher your tax bracket may be and the more you may owe in taxes. Having less taxable income could reduce your tax liability and result in a lower tax bill or a bigger refund.
You may realize another benefit if you anticipate being in a lower tax bracket when you retire. If that’s the case, then taking taxable withdrawals may not have as much of an impact on your tax liability. Also note that contributing to a 414(h) plan doesn’t bar you from contributing to an after-tax savings plan such as a Roth IRA. You’d need to be within the adjusted gross income (AGI) guidelines to contribute to a Roth IRA, but doing so could give you a tax-free source of retirement income to balance out any taxable withdrawals from a 414(h).
One downside, however, is that contributions to a 414(h) plan are not eligible for the Retirement Saver’s Credit. This credit, which is available to taxpayers who are at or below certain income limits, can reduce tax liability on a dollar-for-dollar basis. If you’re counting on maximizing every tax credit possible to lighten your tax burden, missing out on this one could hurt.
A 414(h) plan can help you grow your retirement nest egg if you’re eligible for it. If you’re a government employee with access to a pick-up plan, take time to read your plan documents carefully. More specifically, make sure you understand how much you’re expected to contribute to the plan, how much your employer will contribute, how contributions can be invested and what fees you may pay, if any, for investment or plan management. And if you’re looking to supplement your savings further, consider whether an IRA meets your needs.
Tips for Retirement Planning
- Employer-sponsored 414(h) plans are less common than other types of retirement plans. If you’re a little confused about how they work, it may be helpful to talk to a professional who can explain the details. SmartAsset’s free tool matches you with up to three vetted financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- While your retirement plan is an important part of your financial planning strategy, it’s not the only piece. For example, your plan might include establishing a college savings plan or paying off debt. Talking through all the issues can make it easier to realize your short- and long-term goals.
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