There is a national trend in the ever-evolving healthcare industry that is creating potential control group retirement plan compliance headaches for unsuspecting hospitals. Many hospitals across the country have created health alliances, some formal and others not so formal. Additionally, many hospitals are acquiring previously independent for-profit medical practices and continuing to operate them in that manner.
Most, if not all, of these hospitals offer 403(b) or 401(k) retirement plans and many still maintain defined benefit plans:
- some of which are frozen but not funded well enough to terminate
- others that are closed to new employees but which continue to accrue benefits for existing plan participants
- and the rare instance of an open and on-going plan.
Why does this matter?
The Internal Revenue Service has some complex rules to ensure that an employer’s retirement plan or plans do not discriminate in favor of its “highly compensated employees” (“HCEs” 1) compared to rank and file “non-highly compensated employees” (“NHCEs” 1) with respect to plan coverage (who’s in, who’s out) and plan benefits. For decades, hospitals have maintained retirement programs that covered virtually all their employees and provided contributions and/or benefits on a uniform and nondiscriminatory basis – so what’s the problem?
Control group complexity
The IRS requires an employer’s plan be nondiscriminatory. The issue is that many hospitals and their service providers are focused on nondiscrimination and skip over the first and most important requirement, which is determining who, exactly, is the employer. IRS rules say that the employer is not only the plan sponsor but all other related entities that are under common control – a “control group” (there are also related rules concerning affiliated service groups but those will not be discussed here).
Hospital management is often unaware of these complex rules, or may think that control group rules deal with ownership and so don’t apply in the tax-exempt space.
Their retirement plan practitioners are likely aware of the control group rules and know they apply to tax-exempt entities (or they should), but may not be asking the right management people the right questions to uncover the appropriate facts.
How do the control group rules apply in the tax-exempt world?
In general, common control is deemed to exist between an exempt organization and any other organization if at least 80% of the directors or trustees of one organization are either representatives of, or directly or indirectly controlled by, the other organization. A trustee or director is treated as a representative of another exempt organization if he or she is also a trustee, director, agent or employee of the other exempt organization. A trustee or director is deemed to be controlled by another organization if the other organization has the general power to remove such trustee or director and designate a new trustee or director. Therefore, it is critical that each organization’s board composition be examined as well as its by-laws with respect to who have the authority to appoint and remove such board members.
The result is that many hospitals that have entered into formal alliances are now part of a controlled group of hospitals and no one overseeing their retirement programs is aware of the situation.
Each thinks they are respective “hospital A” sponsoring “plan 1 and plan 2” and “hospital B” sponsoring “plan 3”, but in the eyes of the IRS in its application of all the coverage and nondiscrimination requirements, they are all one employer – the alliance A/B – and within that alliance there are retirement plans 1, 2 and 3, all of which must satisfy these requirements within the context of the consolidated employer A/B.
Example of how unsuspecting hospitals break the rules
By way of a simple example, here is how two previously independent hospitals which are now in alliance may run afoul of the rules. Hospital X sponsors a defined benefit plan with frozen participation, but still covers all its HCEs, while Hospital Y maintains a 403(b) plan with a match for its staff. On its own, each hospital’s plan would satisfy IRS rules, but when looking at Alliance X/Y as the employer, Hospital X’s defined benefit plan may not cover enough of the NHCEs of all X/Y relative to its HCEs and could fail nondiscrimination in coverage. Additionally, Hospital Y’s 403(b) plan fails nondiscrimination in coverage and salary deferral benefits because it is not “universally available” to all employees of the employer X/Y.
Other compliance considerations
There are also other compliance issues to be aware of for hospitals that find themselves in a control group. A number of these concern service. Time spent employed by any member of the control group is considered service for eligibility and vesting for all members of the control group. For example, RN J worked for 3 years at Hospital X above before leaving for Hospital Y. Hospital X and its plan actuary record J as terminated and not vested because J had not completed the required 5 years, but J should not be considered terminated and service with Y must be included for vesting in X’s defined benefit plan. Another common occurrence, LPN K works 30 years at X, then takes early retirement at age 55, goes to work at Y, and commences pension benefits from X’s defined benefit plan. This is not permissible because K is still employed by X/Y and pursuant to IRS rules defined benefit plans may not pay in-service benefits prior to age 62.
These are simple examples with just two related hospitals. Imagine the complexities associated with an alliance that binds four or five hospitals within a control group. Then add the possibility of a hospital-owned medical practice or two that may also have their own plans, and it becomes very apparent that the alliance needs knowledgeable determination and oversight – is there a control group and, if so, who will monitor compliance?
Other compliance concerns include certain PBGC filing requirements for plans that are significantly under funded or that miss contribution due dates. These filings are required to include information on all members of the control group as other control group members may become liable for the plan sponsor’s obligations, an issue that should be vetted prior to any hospital joining any alliance that becomes a control group.
This narrative is not intended to explain all the rules or to suggest that all hospital alliances are control groups rife with compliance problems, but rather to serve as a warning for such hospitals and their service providers that this is a situation that requires considerable attention that may have been previously lacking because the responsible parties didn’t know the rules or those who were asked did not know the relevant facts.
1 An HCE is generally any employee who had gross compensation in excess of a threshold amount in the prior year. This threshold is set by the IRS and periodically increases for cost of living. The threshold for 2018, to be an HCE in 2019, is $120,000. This threshold increases to $125,000 in 2019 for 2020 HCE status. More than 5% owners are also HCEs but that is generally not relevant for tax- exempt employers. An NHCE is any employee who is not an HCE.