IRC 414(h) pick-up contributions are a tax arrangement that lets state and local government employers reclassify their workers’ mandatory retirement contributions as employer contributions for federal income tax purposes. The money still comes out of your paycheck, but because your employer is treated as the contributor, the IRS excludes that amount from your current federal taxable income. You get an immediate federal income tax deferral on the portion of your salary that funds your pension, and you pay income tax on those dollars later, when you take distributions in retirement.1Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
What the Pick-Up Actually Does
The mechanism is a legal fiction. Your government employer formally agrees to treat your required retirement contribution as though the employer made it in lieu of you. The dollars still leave your paycheck, but the deemed contributor is the employer, and Section 414(h)(2) tells the IRS to exclude that amount from your wages for federal income tax purposes.1Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
Only governmental plans qualify. Section 414(h)(2) covers plans established by a state, a political subdivision such as a county or city, or an agency or instrumentality of those entities. Municipal pension systems, county retirement boards, and public school retirement systems all fit. Certain Indian tribal government plans that meet specific requirements also qualify.2Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules
For everything other than current income tax, the contribution is still yours. Your vesting, benefit accrual, and eventual distribution rights are based on the full amount credited to your account. The pick-up changes the tax label on the money, not who owns it.
One boundary to know upfront: 414(h) applies only to mandatory contributions you’re required to pay as a condition of employment or plan participation. Voluntary contributions you choose to make on top of the required amount can’t be picked up. Government workers who want to defer additional amounts voluntarily generally use a Section 457(b) deferred compensation plan or, where available, a Section 403(b) plan.1Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
How the Pick-Up Shows Up on Your W-2
Your W-2 is where the tax treatment becomes visible. The picked-up amount must be excluded from Box 1, Wages, Tips, Other Compensation, which is the figure used to calculate your federal income tax. That exclusion is what delivers your deferral.1Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
The picked-up amount itself typically appears in Box 14, Other, often labeled “414H” or something similar. Box 14 is informational. It doesn’t affect your federal tax calculation, but it lets you confirm the amount that was excluded from Box 1, and it may matter for your state return.
Here’s the part that catches many government employees off guard. Unlike a 401(k) or 403(b) deferral, a 414(h) pick-up generally isn’t excluded from wages for Social Security and Medicare taxes. Your employer must include the picked-up amount in Box 3, Social Security Wages, and Box 5, Medicare Wages and Tips. You still pay the 6.2% Social Security tax and the 1.45% Medicare tax on those dollars.1Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
A quick check: Box 1 should be lower than Boxes 3 and 5 by approximately the amount of your 414(h) contribution. If all three boxes show the same number, the pick-up isn’t being reported correctly, and it’s worth raising with your payroll office.
State Income Tax Doesn’t Automatically Follow
The federal exclusion doesn’t extend automatically to state income tax. Some states follow federal treatment and exclude 414(h) contributions from state taxable income. Others require you to add those contributions back when calculating state tax, which means you owe state income tax on them in the year of contribution even though you don’t owe federal tax until retirement. Check your state’s specific rules, because a required add-back can meaningfully reduce the net benefit of the arrangement.
What Happens When You Take the Money Out
The 414(h) pick-up is a deferral, not an elimination. When distributions from your governmental retirement plan begin, they are taxable in the year you receive them. Under IRC Section 402(a), any amount distributed from a qualified employees’ trust is taxable to the recipient under the annuity rules of Section 72.3Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
In practical terms, your pension payments or lump sum will be taxed as ordinary income at whatever federal rate applies to you in retirement. The implicit bet with a pick-up contribution is that your retirement tax rate will be lower than your working-years rate. For many government employees that’s reasonable. It isn’t guaranteed.
If you leave government employment before retirement, you can generally roll accumulated 414(h) contributions into a traditional IRA or another eligible retirement plan and keep the deferral running. A direct rollover avoids any immediate tax. Taking cash instead means income tax on the full amount, plus a possible 10% early withdrawal penalty if you’re under 59½.
The Age 55 and Age 50 Early Withdrawal Exceptions
Distributions before age 59½ from a governmental plan funded by 414(h) contributions are generally subject to a 10% additional tax. Several exceptions apply, and one matters especially for government workers: if you separate from service during or after the year you turn 55, the 10% penalty doesn’t apply to distributions from your governmental plan. For qualified public safety employees of a state or political subdivision, that threshold drops to 50. The lower age covers law enforcement officers, firefighters, corrections officers, customs and border protection officers, and air traffic controllers, among others.4Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
Important limit on that exception: it only applies to distributions taken directly from the governmental plan. Roll the money into an IRA first, then withdraw, and the exception is gone. You’d face the 10% penalty unless a separate exception covered you. This is a common and expensive mistake for government employees who retire early and reflexively consolidate everything into an IRA before tapping it.
When a Pick-Up Isn’t Really a Pick-Up
A pick-up doesn’t happen automatically. Your government employer has to take formal, authorized action to establish it, and that action can’t be applied retroactively. If the employer never properly adopted the arrangement, or the documentation doesn’t meet IRS requirements, the contributions revert to being plain employee wages, subject to both income tax and employment tax withholding like ordinary pay.5Internal Revenue Service. Private Letter Ruling 201601013
Contributions made before the employer took the necessary formal action stay taxable as employee wages for those periods, and an employer that discovers the problem can’t cure it by passing a resolution now and reaching backward.6Internal Revenue Service. Memorandum – Private Letter Ruling 202041004 From the employee side, the signal that something is off is usually the W-2: if the picked-up amount isn’t being excluded from Box 1, the arrangement isn’t being treated as a valid 414(h) pick-up for federal tax purposes, and the fix is with the employer’s payroll and human resources office rather than on your individual return.