Employee Benefits Law Blog

State and local governmental employers in Michigan have several options when structuring retirement benefits for their workforce. Unlike private employers, governmental entities are generally not subject to ERISA and instead operate within a framework established primarily under the Internal Revenue Code, state law, and local ordinances or charters. As a result, public employers often have flexibility in plan design but must still consider administrative complexity, workforce objectives, and long-term financial commitments.

This article provides a high-level overview of the most common retirement plan structures used by governmental employers, including defined benefit pension plans, 457(b) deferred compensation plans, 401(a) defined contribution plans, and hybrid approaches that combine elements of these structures.

1. Defined Benefit Plans

Defined benefit plans have historically been the foundation of public sector retirement systems. Under a defined benefit plan, the employer promises a specific retirement benefit that is typically calculated using a formula based on years of service, final average compensation, and a benefit multiplier. For example, a typical formula might provide a benefit equal to 1.5 percent multiplied by years of service multiplied by final average compensation.

Benefits are generally paid as lifetime annuities beginning at retirement. Many Michigan public employers participate in statewide systems such as Michigan Municipal Employees' Retirement System (MERS), while others maintain standalone pension plans. Defined benefit plans can be valuable recruitment and retention tools, but they also create long term funding obligations and require actuarial valuations and ongoing monitoring.

2. 457(b) Deferred Compensation Plans

A 457(b) plan is a deferred compensation arrangement that allows governmental employees to voluntarily defer a portion of their salary into a tax deferred retirement account. Governmental 457(b) plans are distinct from the 457(b) plans sponsored by tax exempt organizations. Tax exempt employer plans are typically unfunded “top hat” arrangements maintained for a select group of management or highly compensated employees. By contrast, governmental 457(b) plans must hold plan assets in a trust or custodial account for the exclusive benefit of participants and beneficiaries

One unique feature of governmental 457(b) plans is that distributions may generally begin upon separation from service without the ten percent early withdrawal penalty that applies to many other retirement plans.

Public employers frequently offer a 457(b) plan as a supplemental retirement savings vehicle that allows employees to increase their retirement savings beyond what is provided through a pension or employer funded plan. Most 457(b) plans are funded through employee salary deferrals, although some employers also make contributions. Plan assets must be held in a trust or custodial account for the exclusive benefit of participants and beneficiaries.

3. 401(a) Defined Contribution Plans

A 401(a) plan is a qualified defined contribution plan that can be structured in a variety of ways for governmental employers. Unlike 457(b) plans, which are typically funded through voluntary employee deferrals, 401(a) plans are often funded primarily through employer contributions.

Public employers commonly use 401(a) plans as the core employer funded retirement benefit, particularly where a traditional pension plan is not offered. Contributions may be structured as a fixed percentage of compensation or as discretionary contributions determined by the employer. These plans often operate alongside a 457(b) plan, with the 401(a) plan providing employer contributions and the 457(b) plan providing voluntary employee savings opportunities.

4. Hybrid Retirement Structures

Many governmental employers have adopted hybrid retirement structures that combine elements of defined benefit and defined contribution plans. For example, an employer may offer a smaller defined benefit pension combined with a defined contribution plan, or a 401(a) plan that provides employer contributions alongside a voluntary 457(b) plan.

Another common structure among public employers is to provide employer funded retirement contributions through a 401(a) plan while also offering a voluntary 457(b) plan that allows employees to make additional salary deferrals. Because the contribution limits for 401(a) plans and 457(b) plans are separate, employees may be able to receive employer contributions under the 401(a) plan while also deferring up to the full 457(b) limit. This structure can significantly increase the total amount that may be saved for retirement each year.

5. Choosing the Right Retirement Plan Structure

There is no single retirement plan structure that works for every governmental employer. The appropriate design depends on factors such as workforce size, recruitment and retention goals, financial resources, and existing retirement commitments.

Governmental employers considering changes to their retirement programs should carefully evaluate the legal, tax, and administrative implications of different plan structures. Members of our Employee Benefits practice regularly advise Michigan public employers on the design, amendment, and administration of governmental retirement plans.

If you have questions about your organization’s retirement program or are considering implementing or modifying a retirement plan, please contact a member of our Employee Benefits Group.