What Are FICA Replacement Plans and How Do They Work?

FICA replacement plans are retirement arrangements that state and local government employers use in place of Social Security for certain workers. Under Section 3121(b)(7)(F) of the Internal Revenue Code, an agency can exclude an employee from Social Security tax if that employee participates in a qualifying retirement system instead. To qualify, the plan must credit at least 7.5% of the worker’s pay to a retirement account each period, and every dollar must belong to the employee immediately. These plans are used almost exclusively for part-time, seasonal, and temporary public employees who don’t participate in the employer’s primary pension.¹

Who Gets Enrolled

These plans aren’t a broad opt-out from Social Security. They apply only to a defined slice of the public workforce: employees who fall outside the employer’s main pension system because they don’t work enough hours or stay long enough to qualify for it. Treasury regulations set out three eligible categories:

Part-time employees who normally work 20 hours or less per week.
Seasonal employees who normally work full-time for fewer than five months per year.
Temporary employees working under a contract of two years or less.²

Public universities, community colleges, and school districts are heavy users. Adjunct faculty, graduate assistants, substitute teachers, and seasonal maintenance staff commonly land in replacement plans because they don’t meet the thresholds for the state pension. When a worker moves into a full-time or permanent role, the employer typically shifts them into the primary retirement system and starts standard FICA withholding.

The 7.5% Contribution Floor

For a defined contribution plan to serve as a legitimate FICA replacement, total allocations to each participant’s account must equal at least 7.5% of the employee’s compensation for the coverage period. That percentage is the floor set in the Treasury regulations, not a target.²

Employer matching contributions count toward the 7.5%. In practice, most plans run the full amount as a mandatory pre-tax payroll deduction. Some agencies split the obligation, kicking in part themselves alongside a smaller employee deduction. However the split works, the combined total has to hit the minimum every pay period. Falling short can jeopardize the plan’s tax-favored status and leave the agency owing back FICA on every participant.

For comparison, the combined employer-employee Social Security tax is 12.4% of wages up to the taxable wage base. The 7.5% floor is lower, so replacement plans aren’t trying to match Social Security dollar for dollar. The goal is to make sure participants are actually building retirement savings rather than being left with nothing.

Immediate Vesting

One of the strongest features of these plans for workers is immediate, full vesting. The Treasury regulations require any benefit used to qualify a part-time, seasonal, or temporary employee as a plan participant to be 100% nonforfeitable when it’s credited.² No waiting period. No cliff schedule. If you leave after a few months, the account is still yours.

If the plan terminates or the employer stops contributing entirely, participants keep their balances. The administrator has to distribute the funds or continue holding them in trust for participants. A change in providers or a plan shutdown doesn’t cost you what’s in the account.

Medicare Tax Still Comes Out

Participating in a FICA replacement plan does not exempt you from Medicare tax. Section 3121(u)(2) requires the definition of “employment” for Medicare hospital insurance tax to be applied without regard to the state and local government exclusion. The replacement plan removes Social Security tax only.¹

The Medicare rate is 1.45% for the employee and 1.45% for the employer, totaling 2.9%. Workers earning more than $200,000 in a calendar year owe an additional 0.9% on wages above that threshold, with no employer match on the extra amount.³ For anyone hired in the last four decades of public service, Medicare withholding is not optional.

How the Plans Are Structured and Held

Replacement plans are usually set up as 401(a) defined contribution plans or 457(b) deferred compensation plans. Both can satisfy the 7.5% minimum, but they differ in how distributions are taxed and when penalty-free withdrawals become available. Defined contribution arrangements are the more common form: each participant has an individual account, and the eventual balance depends on contributions plus investment returns. Some agencies use a defined benefit design instead, promising a specific monthly payment at retirement based on salary and years of service.

Whatever the structure, plan assets must sit in trust, separated from the agency’s operating funds. Fiduciaries managing those assets have to act in participants’ interest. A city or county can’t pull from the retirement trust to cover a budget gap.

Participants are entitled to periodic benefit statements. In plans where workers direct their own investments, statements go out at least quarterly. In plans where the employer controls investment decisions, annual statements are the minimum. Statements must show the value of each investment in the account, and defined contribution plans must include illustrations that translate the balance into estimated monthly lifetime payments.⁴

What Enrollment Means for Your Social Security

For decades, non-covered public employment carried two significant penalties on the Social Security side. The Windfall Elimination Provision reduced your own retirement benefit if you also drew a pension from work outside Social Security. The Government Pension Offset could eliminate spousal or survivor benefits entirely. Both were repealed by the Social Security Fairness Act, signed on January 5, 2025. December 2023 was the last month either provision applied, and for benefits payable from January 2024 forward, neither WEP nor GPO reduces anyone’s check.⁵

Time in a replacement plan job still doesn’t produce Social Security earnings credits. If your entire career sits in non-covered positions, you generally won’t qualify for Social Security retirement benefits on your own record, since eligibility requires 40 quarters of covered employment. The replacement plan account becomes the primary retirement vehicle for those years.

The SSA-1945 Notice

Federal law requires state and local government employers to notify new hires when a position isn’t covered by Social Security. Under Section 419 of the Social Security Protection Act of 2004, the employee must sign Form SSA-1945 before starting work. The form explains that earnings from the position won’t count toward Social Security eligibility or benefit calculations, and a copy has to go to the pension-paying agency. The requirement applies to anyone hired on or after January 1, 2005, into a non-covered position.⁶

Getting Your Money Out

When you leave the government job, you can access the funds in your replacement plan account. The administrator will send a notice laying out your options, which usually come down to three: leaving the balance in the plan if allowed, taking cash, or rolling the money into another retirement account.

A lump-sum cash distribution is the simplest and the most expensive. The payment is taxed as ordinary income, and the administrator withholds 20% for federal taxes on eligible rollover distributions over $200. If you’re under 59½, you may also owe a 10% early withdrawal penalty on top of regular income tax.⁷ Governmental 457(b) plans generally don’t trigger that 10% penalty regardless of age, though regular income tax still applies.

A direct rollover avoids both the withholding and the penalty. You instruct the administrator to transfer the balance straight to an IRA or another eligible retirement plan. Because the money never touches your hands, nothing is withheld and no early distribution penalty applies.⁸ If instead you receive a check made out to you and want to roll it over, you have 60 days to deposit it in a qualifying account. Miss the window and the whole amount is taxable income for the year.

Required Minimum Distributions

Replacement plan accounts follow the same required minimum distribution rules as other tax-deferred retirement plans. You generally must begin annual withdrawals in the year you turn 73.⁹ The RMD age is scheduled to rise to 75 for individuals reaching that age after December 31, 2032. Failing to take the full RMD by the deadline triggers an excise tax on the shortfall.

Tax Reporting

When the administrator processes a distribution of $10 or more, it goes on Form 1099-R sent to you and the IRS. The form shows the gross amount, the taxable portion, and any federal tax withheld, and you’ll need it to file your income tax return for the year.¹⁰ Direct rollovers also generate a 1099-R, but the taxable amount is reported as zero and a distribution code marks it as a rollover.

1
Office of the Law Revision Counsel. 26 USC 3121 – Definitions
2
eCFR. 26 CFR 31.3121(b)(7)-2 – Service by Employees Who Are Not Members of a Public Retirement System
3
Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
4
U.S. Department of Labor. Reporting and Disclosure Guide for Employee Benefit Plans
5
Social Security Administration. Social Security Fairness Act: Windfall Elimination Provision (WEP) and Government Pension Offset (GPO) Update
6
Social Security Administration. Statement Concerning Your Employment in a Job Not Covered by Social Security (Form SSA-1945)
7
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
8
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
9
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
10
Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc.