Characterizing employment settlements for pension purposes

Employees lucky enough to be part of an employer-sponsored retirement plan in California have long been familiar with the calculations that go into establishing retirement income. Commonly, the calculation is based on a combination of years worked and highest annual income: but what happens if that annual income spikes because of an employment settlement?

In Molina v. Board of Admin. of California Public Employees' Retirement System ,(Cal.App. 2 Dist.) the Second District, Division Three Appellate Court (covering Los Angeles)has just ruled that wrongful termination settlement proceeds should not be included in a CalPERS pension calculation. CalPERS, or California Public Employees' Retirement System, provides retirement benefits to more than 1.6 million public employees and 3,000 public employers. In short, if you have any other State of California retirement plan, it is likely that this case will apply.

In Molina, a former employee of a local municipality received a $200,000 settlement on a wrongful termination claim. For tax purposes, the settlement was deemed "back pay" and counted towards the employee's taxable income. However, the $200,000 was not "compensation earnable" and did not count towards the CalPERS pension calculation.

Here, the Appellate Court ruled that under the Public Employees Retirement Law (PERL), a settlement only counts towards pension calculation if it it qualifies as "payrate" or "special compensation." There are some technical elements that also protected CalPERS from rewarding the former employee with a higher pension that he would otherwise have earned. In this case, the settlement payment was not the employee's "payrate" because after the settlement the employee was reinstated for one day rather than a year, and the employee was reinstated at his normal monthly rate rather than at a published monthly payrate that would have generated $200,000 in yearly compensation. The payment also was not "special compensation" absent evidence that it was available to similarly situated employees under a labor policy or federal requirement.

Knowing the tax implications of a potential settlement with an aggrieved employee can give you the upper hand in negotiating a claim, but as with all legal matters, you should consult an attorney before doing so. Nothing in this blog is intended to give legal advice or form an attorney-client relationship, and the information herein is offered as a service to clients and the community, not as advertising. I offer free consultations to employers on employment law matters in Santa Barbara, Ventura and San Luis Obispo Counties, and am happy to take your call.