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Retiree health benefit - pre-tax contributions


Guest cwethje
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Guest cwethje

A client has inquired as to whether municipal employees can make pre-tax contributions for future retiree health benefits. An insurance company tells them this is permitted under the Code, does anyone know the authority for such?

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I've seen these and have my doubts. I would like to see more responses to your question.

Here are my thoughts without the benefit of research:

1. This works for union employees if the contributions are required under a collective bargaining agreement and the employees cannot elect whether or how much to contribute.

2. This probably does not work for nonunion employees unless the contributions are funded by the employer. If the contributions are funded by the employees, the contributions probably are made under individual elections, even if not cast as such, and so are after-tax, because of state laws that prohibit wage withholding without the employee's or the union's consent. The way I've seen insurers try to get around the individual election problem for nonunion employees is to divide employees into groups and have the group specify by majority vote a contribution requirement that applies to all group members. The problem I see with this is that the group, consisting of nonunion employees, is not a collective bargaining unit and so its vote does not cause the wage withholding to be made under a collective bargaining agreement. So the employer risks penalties under state wage laws for illegal wage withholding.

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An employer can make pre-tax contributions for retiree medical benefits. If employees make contributions to such an arrangement, the contributions can either be: (i) pre-tax for payment of current premiums; (ii) pre-tax as contributions to a flex arrangement and subject to the "use it or lose it" requirement, or (iii) after-tax contributions. This is addressed in Prop. Regs. under 125.

More likely, the insurance company's representative lied.

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Before we get into the tax issues, does anybody know an insurance co that will accept contributions for health ins to be paid at some unknown date in the future? I dont know of any insurer who will guarantee health benefits to be paid out in the future. What benefit is this insurer willing to pay?

mjb

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Setting aside funds to pay future retiree medical premiums/benefits does not require an insurance company. All kinds of corporations and governmental entities have adopted retiree medical plans. FAS 106 provides guidelines for valuing them and recognizing their costs on current financial statements.

To answer your question directly, I have attempted to negotiate with various insurance companies to provide future retiree medical benefits for current employees. Because medical COL increases are going up faster than current investments, they have declined the opportunity to lock in their rates for future benefits.

However, the lack of insurance company guarantees is a primary reason for employers to set up funding schemes for future retiree medical obligations.

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While an employer can set up a plan to provide for pre tax contributions for retiree health care ( VEBA), 401(h), etc ) there is no vesting requirement. So what would the assurances be to the employees that they would actually get the benefits. If the amounts are vested then the employees will be taxed on amount deferred unless a 401(h) plan is used.

mjb

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I agree that there is no vesting requirement for such benefits under a welfare plan. However, that does not mean either: (1) that the accounts cannot be "earned" or "vested", or (2) that amounts that are earned or vested are taxable.

Earned or vested welfare benefits are still only payable in the event of the actual happening of the unpredictable contingent event (death, disability, incurring medical expenses, etc.) provided for.

So what does vested or earned even mean in the welfare benefit arena? For welfare plans as well as retirement plans the vesting or earning of benefits refers to the benefits that will not be forfeited and will still be available to the participant after termination of employment.

Several assurance are available to the participant, primarily the plan provisions themselves. Also the provisions of the trust agreement should protect the participant's interest somewhat.

The IRC section 411(d)(6) anti-cutback provision does not apply to welfare plans, but there is no reason similar provisions cannot be included in a welfare plan, particularly in the case of a collectively-bargained plan.

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V: My concern with taxability upon vesting derives from Section 83 -transfer of property for the performance of services: Reg. 1.83-3(e)- Section 83 property includes a benefical interest in assets which are set aside or transferred from the claims of the creditors of the transferor e.g, in a trust or escrow account.

mjb

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