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August 14, 1997

by Cynthia L. Moore, Washington Counsel
National Council on Teacher Retirement

Provisions Relating State and Local Government Pension Plans:

1) Here is a list of provisions that directly affect some or all state and local government plans:

• Sec. 1504. Modification of 403(b) Exclusion Allowance to Conform to 415 Modifications
  
  
• Sec. 1505. Extension of Moratorium on Application of Certain Nondiscrimination Rules to State and Local Governments
  
  
• Sec. 1526. Portability of Permissive Service Credit Under Governmental Pension Plans
  
  
• Sec. 1527. Removal of Dollar Limitation on Benefit Payments from a Defined Benefit Plan Maintained for Certain Police and Fire Employees
  
  
• Sec. 1528. Survivor Benefits for Public Safety Officer Killed in the Line of Duty
  
  
• Sec. 1529. Treatment of Certain Disability Benefits Received by Former Police Officers or Firefighters

2) Other items of interest to state and local government plans:

• Sec. 1042. Termination of Certain Exceptions from Rules Relating to Exempt Organizations which Provide Commercial-Type Insurance (Relates to the tax status of TIAA-CREF)
  
  
• Sec. 1071. Pension Accrued Benefit Distributable Without Consent Increased to $5,000
  
  
• Sec. 1073. Repeal of Excess Distribution and Excess Retirement Accumulation Tax
  
  
• Sec. 1075. Basis Recovery Rules for Annuities Over More than One Life
  
  
• Sec. 1509. Clarification of Disqualification Rules Relating to Acceptance of Rollover Contributions
  
  
• Sec. 1525. Section 401(k) Plans for Certain Irrigation and Drainage Entities

Summary of Key Provisions

Nondiscrimination Relief (Section 1505)

Background: Under the nondiscrimination rules, pension plans cannot be discriminate in favor of highly compensated employees. State and local government plans are established through the legislative process making the possibility of abusive plan structures very remote. Although the rules apply to state and local government plans, IRS has granted the plans a temporary moratorium on the rules' application for the last 20 years.

Legislative Action: Section 1505 makes permanent the temporary moratorium and thereby relieves state and local plans from the administrative burden, including the annual testing and data gathering requirements that the rules require.

Effective Date: The change is effective for taxable years beginning on or after the date of enactment of this Act. Governmental plans maintained by state or local governments are treated as satisfying the rules for past years.

Permissive Purchase of Service Credit (Section 1526)

Background: A conflict frequently exists between state laws allowing participants in state and local government plans to purchase permissive service credit (PSC) and the Section 415(c) defined contribution limits. Under Section 415(c), as interpreted by the IRS, the amount that a participant can purchase is limited to 25% of his/her compensation or $30,000, whichever is lower. State law frequently allows participants to buy credit in excess of the limits.

Legislative Action: The relief in Section 1526 is designed to eliminate the conflict. Under the change, contributions by a participant in a state or local government plan to purchase PSC are subject to one of two limits. Either the accrued benefit derived from all contributions to purchase PSC must be taken into account in determining whether the defined benefit pension plan limit is satisfied OR all such contributions must be taken into account in determining whether the $30,000 limit on annual additions is met for the year (taking into account any other additions of the participant). PSC is generally defined as service credit recognized by the governmental plan. Amounts that plan participants withdrew and then redeposited into the same plan or into another public plan within their state would not be subject to the Section 415 limits.

Effective Date: Section 1526 includes a broad grandfather to protect the rights of existing participants and existing plan provisions. For individuals who join the plan after the grandfather period and for new plan provisions, several limitations apply. Those individuals could not purchase more than 5 years of "nonqualified service" and would have to have had participated in the plan for at least 5 years. "Nonqualified service" is not defined, except for what it does not include. Specifically, it does not include service as an employee with a government (federal, state, or local), including certain types of leave; service with a public, private, or sectarian elementary or secondary school (including certain types of leave); service with an employee association; or military service. Except for military service, a participate could not "double dip," i.e., receive credit in two or more plans for one period of service. "Nonqualified service" is intended to be a "catch-all," and includes such service as private sector service (if the plan permits such service to be purchased.)

Police and Fire Fighter Provisions

Dollar Limitations under Section 415 (Section 1527): The Section 415 dollar limits restrict the size of an individual's annual pension benefit. The limit is actuarially reduced for those who retire early. The reductions can have a particularly adverse effect on public safety workers. The change makes inapplicable the reductions in the dollar limit on benefits for public safety workers retiring before age 65. The provision is effective for years beginning after December 31, 1996.

Survivor Benefits for Safety Officers Killed in the Line of Duty (Section 1528): Under existing law, the annuities paid to survivors of military service personnel killed in combat are excludable from taxable income. The change generally extends this tax treatment to the survivors of police officer and fire fighters. The provision applies to amounts received in taxable years beginning after December 31, 1996, with respect to individuals dying after that date.

Treatment of Certain Disability Benefits Received by Former Police Officers or Firefighters (Section 1529): Under the change, certain payments made on behalf of full-time employees of any state or local government police or fire department are excludable from income. The change applies to payments made on account of heart disease or hypertension of the employee and were received during certain years.

For a copy of the relevant bill text and legislative history, contact Cynthia L. Moore at 703-243- 3494 or Bruce Hineman at 512-335-0055.