A pickup contribution is a mandatory retirement contribution that a state or local government employer reclassifies as an employer payment under Internal Revenue Code Section 414(h)(2), so that the money is excluded from your federal taxable wages even though it still comes out of your paycheck. The arrangement is unique to public sector workers. It lowers your federal income tax every pay period without changing where the money actually comes from.
How the Mechanism Works
Section 414(h)(2) says that when a governmental employer “picks up” contributions a plan designates as employee contributions, those amounts are treated as employer contributions instead.1Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules One sentence of tax code does the work. The contribution bypasses your gross income for federal income tax purposes, even though your pay stub still shows the deduction and your take-home pay still drops by that amount.
The key word in the statute is mandatory. A pickup only works when you have no choice about contributing. State and local pension systems typically require participants to contribute a fixed percentage of salary as a condition of employment, and that fixed, non-negotiable contribution is exactly the kind of payment Section 414(h)(2) was written for. The economic reality does not change. The money still comes from your compensation. The legal fiction that the employer paid it on your behalf is what triggers the income tax exclusion.
What Makes a Pickup Valid
The IRS set out two conditions in Revenue Ruling 2006-43, and both have to be met.2Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans
First, the employing unit must adopt a formal resolution (or equivalent formal action) specifying that contributions designated as employee contributions will be paid by the employer in lieu of employee contributions. An informal practice or verbal arrangement does not qualify.
Second, employees cannot be given a cash-or-deferred election. You cannot be allowed to take the money as cash instead, opt out, or otherwise choose between the contribution and direct pay. That absence of choice is what distinguishes a pickup from a 401(k)-style elective deferral. In a 401(k) you decide how much to put in. In a pickup you have no say at all, and the lack of choice is precisely what makes the tax treatment work. If an employer offered a cash alternative, the arrangement would fail and every dollar contributed would be taxable as ordinary income.
What You Save on Federal Income Tax
The payoff is straightforward: the contributed amount is excluded from your gross income for federal income tax purposes.2Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans If you earn $60,000 and your pension system requires an 8% contribution that your employer picks up, your taxable income drops by $4,800. At a 22% marginal federal rate, that is roughly $1,056 kept each year.
You do not claim this as a deduction on your return. It happens at the payroll level, so the money never appears as taxable wages in the first place. And this is a deferral, not a permanent break. Amounts attributable to pickup contributions are taxed as ordinary income when you later receive pension payments or withdraw from the plan. The benefit is that most retirees are in a lower bracket than they were while working, so the same dollars get taxed at a lower rate.
FICA Is a Different Story
Pickup contributions reduce your federal income tax. They usually do not reduce your Social Security and Medicare tax. Whether FICA applies depends on how the employer funds the pickup.
If the employer funds it by reducing your salary or offsetting what you would otherwise be paid, the contributions are treated as a salary reduction and stay subject to FICA.2Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans This describes most pickup arrangements. Your pay stub shows a deduction, your take-home drops, and FICA is calculated on the full pre-deduction salary.
In the less common case, the employer pays the contribution as a genuine salary supplement on top of ordinary pay raises. If the facts show no wage reduction or offset, the amount can be excluded from FICA wages too.2Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans This is rare because most governments fund pickups through salary offsets rather than extra budget outlays.
For most public employees, then, the pickup is pre-tax for income tax and after-tax for FICA. You still pay the 6.2% Social Security tax (on wages up to $184,500 in 2026) and the 1.45% Medicare tax on the pickup amount.3Social Security Administration. Contribution and Benefit Base One upside: those contributions still count toward your Social Security earnings record, which can support a higher benefit later.
How to Spot a Pickup on Your W-2
The split tax treatment shows up on your Form W-2. Because the pickup is excluded from income tax, it is subtracted from Box 1 (wages subject to federal income tax).4Internal Revenue Service. Retirement Plan FAQs Regarding Contributions When the contributions remain subject to FICA, the full salary stays in Box 3 (Social Security wages) and Box 5 (Medicare wages).2Internal Revenue Service. Employer Pick-Up Contributions to Benefit Plans If you notice that Box 1 is lower than Boxes 3 and 5, a pickup contribution is almost certainly the reason.
Pickup contributions to a 401(a) defined benefit plan generally do not use a Box 12 code. The income tax exclusion is reflected entirely through the reduced Box 1 figure. Some employers list the pickup amount in Box 14, which is informational and has no direct effect on your return. For governmental 403(b) plans, elective deferrals are reported in Box 12 with Code E, which is a separate arrangement from a pickup.5Internal Revenue Service. Common Errors on Form W-2 Codes for Retirement Plans
What Happens at Retirement or If You Leave
Because pickup contributions were never taxed as income going in, they are fully taxable as ordinary income coming out. Each pension payment in retirement includes a portion attributable to your pickup contributions, and that portion is taxed at your regular income tax rate for the year you receive it.
If you leave government employment before retirement, the pickup balance in your plan may be eligible for a direct rollover into an IRA or another qualified plan, depending on plan rules. A direct rollover preserves the tax deferral. Taking the money as a lump sum without rolling it over makes the full amount taxable in the year received, and if you are under 59½, a 10% early withdrawal penalty generally applies on top.
State Income Tax
Federal treatment does not control state treatment. Most states follow the federal rule and exclude pickup contributions from state taxable income, but some require you to add the pickup amount back to your state adjusted gross income, which makes it pre-tax federally and after-tax for state purposes. Check your state’s rules for Section 414(h) contributions, or look at how your state’s instructions tell you to adjust federal Box 1 wages.
Who Uses Pickup Contributions
Only governmental entities. Section 414(h)(2) limits the treatment to plans established by a state, political subdivision, or any agency or instrumentality of either.1Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules That covers state governments, counties, cities, public school districts, state university systems, and similar public employers. The most common home for pickups is a governmental defined benefit pension plan under Section 401(a), the kind that covers teachers, firefighters, police officers, and other career public employees.
Private sector employers do not use pickups. Their plans rely on elective 401(k)-style deferrals, which reach a similar federal income tax result through a different legal path and are likewise generally subject to FICA.4Internal Revenue Service. Retirement Plan FAQs Regarding Contributions If you work in the private sector, pickups are not available to you.