Wise Information for K‑12 Employees



Why Charter Schools Need to be Aware of ERISA

If you’re founding or running a charter school, complying with regulations about retirement benefits is probably the last thing in your mind. You probably sign up with the first person who offers a plan and move along to your never-ending to do list. While understandable, this poses an enormous risk that many school leaders are unaware of. And as the percentage of students attending charter schools increases (It’s around 95% here in New Orleans, the highest in the nation.), there are going to be more and more new organizations popping up that need to know the rules governing retirement benefits.

While you would think these employers could rely on financial advisors to know all the rules of ERISA, the legislation designed to protect employee retirement accounts from misdeeds by employers, I’ve found that’s often not the case, particularly when it comes to 403(b)’s. Given that that penalties for not filing required annual reports and violating ERISA can be steep (Up to $15,000 from the IRS, and up to $2,097 per day [with no maximum] from DOL), it’s vital to get this right. Over the past 4 months I’ve been on a journey of figuring out where charter schools fall in terms of ERISA regulations, so come along for the ride.

Most Charters Are Non-Profit

The overwhelming majority of charter schools are non-profit, public schools. Anyone who knows me knows I am quick to correct someone who assumes all charter schools are for-profit. In fact, only about 13% of charter schools are for-profit entities. Given that charter schools are public schools, we could assume they are considered a part of the government, and not subject to the rules and regulations binding private entities, right? However, this gets into the technical definition of what is a “government entity,” and the distinction is critical to charter school operators who have 403(b) (and 401k) plans for their employees.

403(b) Over Pension

When given a choice, many charter schools have opted not to enroll their staff in underfunded pension plans, and instead they participate in 403(b) retirement plans as their sole retirement benefit. In the past, the majority of 403(b) plans were run by school districts, which are government entities, and thus the plans were not subject to the normal regulations in ERISA, which aims to protect the retirement savings of employees. However, the regulations regarding being exempt from ERISA read:

“The provisions of this title shall not apply to any employee benefit plan if such plan is a governmental plan.”

Are Charter Schools Governmental Plans?

This brought me to a question: Are charter schools retirement plans governmental plans? Many charter schools have assumed that they are governmental plans since they are public schools. But recent evidence points to both the IRS and Department of Labor (DOL) disagreeing, finding that charter schools are not governmental plans and therefore are subject to the same reporting, testing, and non-discrimination rules as private employers.

The question that needs to be answered is: What makes a plan a governmental plan? There have been many cases over the years that hinge on the answer to this question, and according to IRS Revenue Ruling 57-128, the tests that are applied are as follows:    

  1. whether it is used for a governmental purpose and performs a governmental function;
  2. whether performance of its function is on behalf or one of one or more states or political subdivisions;
  3. whether there are any private interests involved, or whether the states or political subdivisions involved have the powers and interests of an owner;
  4. whether control and supervision of the organization is vested in public authority or authorities;
  5. if express or implied statutory or other authority is necessary for the creation and/or use of such an instrumentality, and whether such authority exists; and
  6. the degree of financial autonomy and the source of its operating expenses.

This is where I almost lost the thread myself, so I’ll jump you right to the conclusion of a 2015 IRS Memo, which applied the above tests to whether a particular charter school is governmental:

“Although all six factors described in Revenue Ruling 57-128 are considered in determining whether an organization is an instrumentality of a government, the mere satisfaction of one or more of the factors is not necessarily determinative. The determination ultimately requires consideration of the totality of the circumstances. Although Charter School X is publicly funded and performs the governmental function of providing public education in State A, it does not perform this function on behalf of State A because State A exercises no meaningful control over Charter School X's day-to-day operations or its budget and the laws of State A permit Charter School X to operate independently from the local school district. No governmental entity has the power to appoint Charter School X's governing board and the organization's bylaws permit management to be delegated to a private management company. Based on the above analysis, we conclude that Charter School X does not qualify as a wholly-owned instrumentality of the state or of a political subdivision of the state for purposes of FICA tax liability under Code section 3121(b)(7)(F) with respect to compensation paid to Charter School X's employees.”

Public Funding Doesn't Always Equal Government Entity

Translation: Just because your school is funded with public money doesn’t automatically make it a governmental entity. That distinction is critical because if it’s not a governmental plan, then the employer would have to have limited involvement in the plan to maintain status as not covered by ERISA. Here are the rules to have limited involvement:

  • There can be no employer contributions;
  • The employer must have minimal administrative involvement with the plan; and
  • The plan must be voluntary for plan participants.

Most of the charter schools I know make employer contributions, so they fail this test off the bat. Also, unlike many districts which have a laundry list of 403(b) providers, most charters have just one, which has been selected by the school. Clearly, there goes minimal involvement.  Some schools also auto-enroll employees, which I think is great from a behavioral finance standpoint, but almost means the plan fails the above test.

In addition to the 2015 IRS memo, the Department of Labor has found the same, and recently fined a charter school $50,000 for just one year of non-compliance. That school is now bogged down in an appeal process, but, safe to say no one wants to have that on their plate. I called the DOL myself and they were crystal clear that the rules above are what’s used to determine governmental plans, and they’ve found most charter schools are not exempt from ERISA. Put it all together and if you’re a charter school organized as a 501(c)(3), and you make contributions to your employees 403(b) accounts, you should be following all of the requirements under ERISA. While it’s possible your state law differs and your state considers charter schools governmental, it’s becoming clear that’s not the case in at least some states. This is a major liability for your organization, and given that it’s possible to rectify this without too much headache, it’s well worth fixing.

How to Fix?

Well, there are two pieces to that: Fixing what’s already happened, and making sure you’re in compliance going forward.

To fix past years, there is actually a program specifically designed to do so. The Department of Labor’s Delinquent Filer Voluntary Compliance Program exists to help organizations identify that they weren’t following all the rules, pay a small fine, and eliminate the possibility of an audit and major fine or other consequence in the future. For most organizations, the maximum fine ends up being $4,000 and a bit of paperwork to file the missing Form 5500’s, and then you’re good to go. It’ll take some legwork to get all the data for previous years, but that amount of time and $4,000 seems well worth the benefit of eliminating a potentially organization crippling fine. Using this program can also help minimize IRS fines associated with not filing.

The other change is making sure your plan is compliant with ERISA going forward. The major rules here are all about ensuring your plan isn’t discriminatory, vests employees in a reasonable timeframe, notifies employees of changes, and that the employer can’t raid the funds to cover other shortfalls. It’s all designed to protect the savings of plan participants. In every charter school with a 403(b) that I’ve encountered, this should be a non-issue since the plans are already complying with these rules except for the reporting, which is done by filing form 5500 each year. Again, this isn’t difficult, since most Third-Party Administrators now build this into their services. I’d go so far as to say that if you’re going to be ERISA compliant anyways, I think most charter schools should switch to a 401(k) plan, which function very similarly, but because they’re more highly regulated, tend to cost less, have more investment options, and have more transparency for both employers and plan participants.

I’m not a lawyer, and here’s your obligatory disclaimer that you should consult your own legal advisors to decide on any action. But given the small cost to be in compliance and the massive consequences of not doing so, it’s time all charter school leaders take the time to ensure they’re complying with ERISA, and that the retirement plans they provide to their staff meet the quality bar every teacher deserves.

Founder of Deliberate Finances