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Purchasing Service Credits in a Defined Benefit Plan

“My client has a job with the government. She is asking me about purchasing service credits in her retirement plan. Can you explain what she might be talking about?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Minnesota is representative of a common inquiry related to governmental plans.

Highlights of the Discussion

Generally, service credit is credit for work performed for which your client may earn a benefit under a defined benefit pension plan. Many states allow their public employees to purchase permissive service credits for previous years of service which, otherwise, would not count in the pension. It commonly happens when an employee terminates governmental employment prior to vesting, but later becomes employed in another governmental position [IRC §415(n)]. In order to purchase the service credit, the employee must make a voluntary additional contribution, in an amount determined under such governmental plan, which does not exceed the amount necessary to fund the benefit attributable to such service credit [IRC §415(n)(3)(A)(iii)].

Whether a governmental worker may purchase service credits depends on the particular retirement system. If he or she is eligible, then the retirement system determines the cost of the purchase. The plan usually limits the number of years of service credit that a participant may purchase. The retirement system usually provides different payment options, which may include the following:

  • A lump-sum payment for the full cost;
  • Payroll deductions over a period of time; and
  • Direct rollovers or trustee-to-trustee transfers of amounts from a qualified plan (including a 401(k) plan, a 403(b) plan or state or local government 457 plan).[1]

Conclusion

Because the ability to purchase service credits in a governmental defined benefit plan is dependent on the particular retirement system, reviewing specific plan documentation and forms is essential to determine if the option is available, what payment methods may be used and how to request the purchase.

[1] The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) broaden the third option to permit funds from 403(b) and 457 plans to be transferred on a pretax basis to purchase service credit, or to repay prior cash-outs of benefits, in governmental defined benefit plans. Previously, these transfers were only allowed from qualified plans, such as 401(k) plans.

 

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