How Section 415(m) Governmental Excess Benefit Arrangements Work

A Section 415(m) governmental excess benefit arrangement is a separate plan that a state or local government uses to pay a retiree the portion of their earned pension that sits above the federal ceiling on qualified plan payouts. For 2026, that ceiling is $290,000 per year, or 100% of average high-three-year compensation, whichever is less.¹ When a public employee’s retirement formula produces a benefit larger than that cap, the qualified pension plan pays up to the limit and the excess arrangement pays the rest. The qualified plan keeps its tax status; the retiree gets the full benefit they earned.

Which Employers Can Set One Up

Only sponsors of a governmental plan under Section 414(d) can use this tool. That covers the federal government, every state, and any political subdivision such as a county, city, or township, along with agencies and instrumentalities like public school districts, state universities, transit authorities, and municipal utilities.²

Indian tribal governments can also establish one, but only where their retirement plan qualifies as a governmental plan under Section 414(d), which requires substantially all covered employees to perform essential governmental functions rather than commercial activities.³ Private employers and tax-exempt nonprofits cannot use Section 415(m) at all. It is a public-sector mechanism.

The Three Statutory Conditions

Section 415(m)(3) sets three requirements, and missing any one destroys the arrangement’s status.

The arrangement must exist for the sole purpose of paying the portion of a benefit that exceeds the Section 415(b) cap. It cannot be used for broader retirement savings or supplemental compensation.⁴
Participants cannot elect to defer compensation into it, directly or indirectly. All funding comes from the employer.⁵
If a trust is used to pay excess benefits, it must be maintained solely for that purpose and cannot be commingled with the assets of the primary qualified pension fund.⁵

The separation of assets is the requirement administrators fail most often. The primary pension trust is qualified under Section 401(a), and mixing non-qualified excess benefit obligations into it can jeopardize the qualified status of the entire fund, affecting every participant rather than just those receiving excess benefits.

Calculating the Excess Benefit

The plan administrator computes the participant’s full benefit under the retirement formula, compares it to the Section 415(b) limit for the year, and the difference is what the excess arrangement pays. For 2026, the dollar limit is $290,000 per year, payable as a straight life annuity beginning no earlier than age 62.¹ The alternative ceiling is 100% of the participant’s average compensation for the highest-paid three consecutive years, and the lower of the two figures controls.⁴

So a career executive whose formula produces a $330,000 annual pension would receive $290,000 from the qualified plan and $40,000 from the excess arrangement. The dollar limit is adjusted annually for inflation, and the adjustment reaches people already in pay status.⁴ As the cap rises, the qualified plan share grows and the excess share shrinks. The split does not lock in at retirement.

Early Retirement Reductions

Starting benefits before age 62 actuarially reduces the dollar limit to reflect the longer expected payout, using a 5% interest rate and the IRS mortality table.⁶ A lower effective cap means more of the benefit flows through the excess arrangement, so early retirement pushes participants deeper into reliance on it.

Public safety employees get a significant carve-out. Qualified police officers, firefighters, and emergency medical personnel with at least 15 years of full-time service in a department maintained by a state, tribal government, or political subdivision are exempt from the early-retirement reduction, as are members of the Armed Forces.⁷ The full dollar limit applies to them regardless of the age at which benefits begin, which often eliminates the need for an excess arrangement entirely.

Disability and Survivor Cases

The early-retirement age reduction also does not apply where the participant receives a pension because of a disability from personal injury or sickness, or where a beneficiary, survivor, or estate receives amounts as a result of the participant’s death.⁸ In both situations the full unadjusted dollar limit applies, which can shrink or eliminate the excess benefit portion.

How Benefits Are Taxed to the Retiree

The tax structure is a hybrid. The trust holding excess-benefit assets is treated as performing an essential governmental function, so its investment income is exempt from federal tax under Section 115. The participant’s side is different: benefits are taxed as if the arrangement were a nonqualified deferred compensation plan of a taxable private employer.⁴

For income tax purposes, participants include the excess benefit in gross income when it is actually paid. Because the payments count as deferred compensation from a nonqualified plan, they are reported as wages on Form W-2 rather than as pension distributions on Form 1099-R, and the employer runs the withholding through Form 941, not Form 945.⁹

FICA and Medicare taxes run on a different clock. Under the special timing rule in Section 3121(v)(2), those taxes are assessed when the right to the deferred amount is no longer subject to a substantial risk of forfeiture, not when the benefit is later paid.¹⁰ Once FICA has been paid on a deferred amount, neither that amount nor its earnings are hit again at distribution. In practice, retirees drawing monthly excess-benefit payments generally do not see Social Security or Medicare tax withheld, because the tax was satisfied years earlier during active employment. Whether that timing rule reaches a particular participant depends on whether their service is covered employment under Section 3121(b); employees excluded from Social Security coverage under Section 3121(b)(7) have no FICA obligation on their excess benefits at any stage.

Why the Trust Assets Are Not as Safe as Pension Assets

This is the single most important structural difference between a 415(m) arrangement and the qualified pension underneath it. Assets held in the excess-benefit trust remain subject to the claims of the employer’s general creditors if the employer becomes insolvent or files bankruptcy. Participants hold unsecured contractual rights to their excess benefits, not a property interest in the trust assets.¹¹

Many public employers fund these arrangements through a rabbi trust, which separates the money from the employer’s operating funds but does not shield it from creditors. The IRS provides model trust language in Revenue Procedure 92-64. The trust agreement must state that assets will be available to satisfy creditor claims if the employer becomes insolvent, and the trustee must suspend benefit payments upon receiving notice of insolvency.¹¹

For most state and local governments actual insolvency is rare, so the creditor exposure is more theoretical than practical. Municipal bankruptcies do happen, though, and the excess-benefit portion of a public retiree’s income does not carry the same legal protection as the amount coming from the qualified plan.

What Happens to Survivors

The arrangement does not simply stop when a participant dies. If the retiree elected a joint-and-survivor annuity or named a contingent annuitant under the primary pension plan, the continuing benefit paid to the survivor is tested against the applicable 415(b) dollar limit. Where the survivor benefit exceeds that limit, the excess arrangement keeps paying the difference to the survivor or contingent annuitant.⁶

A younger contingent annuitant receiving a high percentage of the participant’s benefit is more likely to exceed the cap than an older spouse receiving a 50% survivor benefit. The point is that the excess arrangement mirrors whatever benefit form the qualified plan provides. If the qualified plan pays a survivor benefit, the 415(m) arrangement pays the excess portion of that survivor benefit.

1
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
2
Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules
3
Federal Register. Indian Tribal Governmental Plans
4
Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans
5
Internal Revenue Service. Determination Letters for Governmental Plans Don’t Address Pick-up Contributions and Excess Benefit Arrangements
6
eCFR. 26 CFR 1.415(b)-1 – Limitations for Defined Benefit Plans
7
Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans – Section (b)(2)(G)-(H)
8
Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans – Section (b)(2)(I)
9
Internal Revenue Service. Instructions for Form 945
10
eCFR. 26 CFR 31.3121(v)(2)-1 – Treatment of Amounts Deferred Under Certain Nonqualified Deferred Compensation Plans
11
Internal Revenue Service. Private Letter Ruling 200835034