Three basic types of retirement savings plans allow employees to contribute pre-tax contribution of varying amounts at their own election. The appropriate type of pre-tax retirement savings plan for a given employer depends upon the employer's tax status. In order to avoid future tax penalties, hospitals should make certain the plan they operate or make available to their employees is appropriate. If a hospital discovers that it is participating in the wrong type of plan, the IRS sponsors a voluntary correction program that allows the hospital to correct the problem, typically for only a nominal compliance fee. If the same problem were to be discovered in an IRS review or audit, the correction procedures could be significantly more onerous. This article will help you determine whether your retirement program is the correct type for your hospital.
401(k) Plans
The most familiar type of plan is a 401(k) plan. Taxable employers, non-governmental tax exempt entities and those governmental entities with a grandfathered plan are eligible to sponsor a 401(k) plan. To be grandfathered, a governmental entity must have established the plan by May 6, 1986. Governmental entities are not allowed to have a 401(k) plan, unless the plan meets the grandfather criteria.
403(b) Plans
Section 403(b) plans operate on a premise similar to 401(k) plans, but 403(b) plans are not subject to the extensive nondiscrimination testing on the employee elective contributions, although the tests still apply to any matching contributions. Hospitals which are tax exempt entities and which are specifically exempt under Internal Revenue Code Section 501(c)(3) are eligible to sponsor 403(b) plans (also known as 403(b)(7) plans or Tax Sheltered Annuity Plans). Employees of other hospitals are not eligible to contribute to 403(b) plans.
In order to be an organization exempt from tax under Section 501(c)(3), your hospital must have applied for and received a letter from the IRS confirming its tax exempt status. The letter will specifically mention Section 501(c)(3) as the basis for the tax exemption.
Many governmental hospitals have discovered that they have been sold a 403(b) plan for which they are ineligible, because they do not possess a 501(c)(3) letter from the IRS. The IRS voluntary correction program exists to correct this problem.
Section 457 Plans for Governmental Employers
Governmental employers are eligible to sponsor Section 457 plans for their employees. Section 457 plans do not have to comply with the nondiscrimination rules that apply to 401(k) plans and 403(b) plans. In addition, as a result of legislative changes in the last several years, governmental 457 plan assets are now: (a) invested in trusts operated for the exclusive benefit of participants and their beneficiaries, (b) protected from creditors of the hospital in the event of hospital insolvency, and (c) eligible for IRA rollover.
Section 457 Plans for Tax Exempts
Tax exempt institutions may also sponsor a variation of this plan, provided the plan covers only a select group of management or highly compensated employees. These "select group" Section 457 plans do not have to address the nondiscrimination issue, but they would normally be invested in a so-called Rabbi Trust, rather than an "exclusive benefit" trust and are not eligible for IRA rollover and are not protected from hospital creditors in the event of hospital insolvency.
Qualified Plans
In addition to the above plans which each allow pre-tax savings at varying levels at the employee's discretion, any employer may sponsor a qualified retirement plan such as a profit sharing plan, money purchase plan, defined benefit pension plan, target benefit plan, etc. These may be in addition to or in lieu of the pre-tax elective savings plans discussed above. These plans are "qualified" by meeting the qualification requirements of Internal Revenue Code Section 401(a) and are therefore sometimes called 401(a) plans. Governmental employers may also utilize pre-tax employee contributions at a fixed rate of contributions to help fund these plans.
Summary
It is very important for a hospital to sponsor the appropriate type of plan, so the hospital is not exposed to tax withholding penalties and excise taxes and the favorable tax treatment of employees' retirement savings is not jeopardized. The above discussion is summarized in the accompanying table.
If a hospital discovers it is in the wrong program, the IRS has a (relatively) painless procedure for fixing the problem, provided the hospital voluntarily files (under Revenue Procedure 2002-47) to address the situation.
