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Payroll split between 501(c)(3) and state university becomes 100% univ


Ken Davis
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My employer, the University of South Alabama, participates in the Alabama State Teacher's Retirement System (TRS) DB plan. We have a medical school and a medical faculty practice plan (FPP). The FPP is a separately incorporated 501©(3) corporation through which the medical doctor professors carry on their clinical practice, and from which the doctors receive a salary. The FPP does not sponsor a qualified retirement plan. So the medical doctors receive two salary checks - one from the university for their teaching duties and on which the doctors will receive a retirement annuity from the TRS, and one from the FPP for their clinical practice on which no retirement is provided.

Discussions are beginning about folding the FPP into the university for business reasons unrelated to retirement plan considerations. The doctors will continue their clinical practice, only through the university instead of the FPP.

We have discussed the fact that the day after the FPP is dissolved, the TRS DB plan will have a significant unfunded liability with respect to the doctors. In other words, due to the salary formerly paid through the FPP but now paid through the university, the doctors' state paychecks will approximately double overnight, with the same years of service, which will make the TRS annuity approximately double what had been assumed in all previous actuarial projections. Obviously, the TRS will look to the university and the doctors to make up the difference.

The university, like most state institutions, is in no financial position to make up any part of the difference, so the likely outcome is that the doctors themselves will have to fully fund the unfunded liability.

Now, finally to the question. Assuming the doctors do not want to use existing 403(B) or 457 funds to pay the liability. Is there any possible way for the doctors to fund this liability with pre-tax dollars? For example, it seems to me that if Alabama law either currently allows, or could be changed to allow, this buy-in to be "picked up" by the university, pre-tax treatment should be allowed.

I was able to find a couple of letter rulings that were somewhat on point. The first, PLR 20002051, allowed 414(h)(2) treatment for the purchase of service credits for prior employment as a private school teacher and for any employment which the plan's board of trustees deem to enhance the participant's ability to teach in the public school system. The second, PLR 200229051, actually ruled on a retired employee issue, but also described a plan under which existing employees made an irrevocable election to purchase, in exchange for an increased mandatory contribution, an enhanced retirement benefit equal to 2% for each year of creditable service, up to 80% of three-year average salary. The taxpayer didn't request a ruling on the 414(h)(2) impact on existing employees, so if anyone has any insights on such impact I would appreciate hearing them.

Thanks in advance for any thoughts.

Ken Davis

Univ. of South Alabama

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"...the TRS DB plan will have a significant unfunded liability with respect to the doctors."

This may be true, but not necessarily. Depends on plan provisions, and whether any planning is done before "...the FPP is dissolved."

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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