Working in the public sector can provide an employee with some unique retirement benefits that are not generally available to those who work for private companies. One such benefit is a Special Pay Plan, which pays out based on special forms of compensation, such as unused sick leave or vacation pay. These types of compensation are normally paid out as taxable earned income and are reported on a W-2 form. A Special Pay Plan mitigates this tax hit and provides a valuable investment vehicle in the process. If your employer offers a Special Pay Plan, it’s adding value for you in many ways.
What is a Special Pay Plan?
A Special Pay Plan is an interest-bearing 401(a)/403(b) retirement account that is established by your employer in your name. Your employer makes pre-tax deposits/contributions into this account in lieu of disbursing a check for your unused sick leave, separation of service pay, or other retirement incentive pay. The funds deposited into the Special Pay Plan are invested, which leads to earnings over time, helping you to meet your retirement goals.
From a tax perspective, a Special Pay Plan is a valuable benefit in the following ways:
- You will permanently save 7.65% on FICA taxes. For example, if your benefit amount is $10,000, you will take home the entire $10,000 less income tax, saving $765 in FICA.
- Funds in a Special Pay Plan can be available before age 59½ without penalty. If you are at least age 55 at the time of retirement and remain separated from service, you can access the funds and avoid the 10% early withdrawal penalty.
- The account is tax-deferred, meaning that you are not taxed until you withdraw funds. In addition, if your tax bracket is lower after retirement, you could potentially save on tax when you withdraw funds. A Special Pay Plan allows you to control the timing of your cash distributions as well as the timing of your tax obligations.
Other Benefits of the Special Pay Plan
Besides the built-in tax advantages, a Special Pay Plan provides a valuable savings vehicle for your retirement in other ways. During your working years, the benefit continues to grow. Once you retire, you are free to roll the accumulated funds into an IRA or another qualified plan, or take a partial or lump sum distribution. If desired, periodic distributions may be taken monthly, quarterly, or annually. The funds can be used at your discretion, for any expense. This type of plan provides complete liquidity for withdrawals or rollovers, enabling you to manage your financial future on your terms.
As a public sector employee, you already know your retirement benefits offer some unique opportunities. If your employer offers a Special Pay Plan, consider yourself fortunate. This lovely benefit converts otherwise taxable incentives into a tax-advantaged retirement option for you. Having this added sense of financial security may convince you to get off the fence about retiring early.
A Health Reimbursement Arrangement (HRA) is another valuable savings tool that can benefit you in retirement. If your employer offers an HRA, please click here to learn how this benefit can make a difference for you.