A recently issued IRS private letter ruling may provide public agencies and their employees with another way to give employees more control over the types of retirement benefits they will eventually receive.
As we previously reported, governmental employers can provide their employees with the benefits of tax-free reimbursements from a health expense reimbursement arrangement. However, HRAs only can be funded with employer contributions – employees cannot make salary reduction contributions. Governmental employers also can make pre-tax retirement contributions to either a 457(b) plan or a 401(a) plan, but, because governmental employers generally cannot maintain 401(k) plans, employee pre-tax elective contributions generally must be made to a 457(b) plan with its lower contribution limits, not to a 401(a) plan.
Recognizing that there are distinct advantages of both HRAs and 401(a) plans, it is often difficult for public employers and their union bargaining partners to settle on the right “mix” of the plans and benefits. The new IRS private letter ruling specifically gives individual employees the ability to choose the amounts of future employer contributions to an HRA or to a 401(a) plan. For example, in the case of a 401(a) plan and an HRA based on the calendar-year, employees could be given an election in one year that would govern the employer’s contributions to the plan in the next year. Of course, there are certain restrictions and conditions that must be observed to obtain the desired tax treatment:
- The employees’ annual irrevocable elections to receive contributions to either the 401(a) or the HRA must be made before the beginning of the plan year to which the employer contributions relate.
- The employees’ elections will allocate all of the available employer contributions between the plans – the employees cannot elect to receive some of the contributions in cash or in the form of other taxable benefits.
- Amounts elected by the employee as future employer contributions to the 401(a) must comply with the applicable 401(a) plan contribution limits, including any other contributions made for the same year.
- The 401(a) plan and HRA will likely need to be amended to accommodate the contributions contemplated by this new arrangement.
Remember, private letter rulings may not be relied on as precedent by other taxpayers. If you are considering this approach, you should seek appropriate advice of tax counsel. By giving employees a choice between various employer contributions, the parties can provide greater benefit flexibility, can allow employees to better “save” for their own needs and can stretch the budgets of public agencies.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.