H&W plan w Life Insurance

[Gary]

Say a client sponsors a VEBA plan and decides that they want to fund some of the benefits with life insurance.

For one of the participants they want to purchase a poplicy with a face amount of say $1 million.

The participant already has life insurance with a face of $1 million.

Could this policy become part of the plan where the plan sponsor pays future premiums and (as prescribed under IRC 419) only the calculated portion of the premium is the deduction, where the calculated portion includes the amount of premium for one year's of life insurance coverage and for pre-funding the other post retirement medical benefits to be provided by the life insurance cash value at retirement?

This being considered as an alternative to implementing an additional policy.

Thanks.

[Guest San Diego Benefits Guy]

Say a client sponsors a VEBA plan and decides that they want to fund some of the benefits with life insurance.

For one of the participants they want to purchase a poplicy with a face amount of say $1 million.

The participant already has life insurance with a face of $1 million.

Could this policy become part of the plan where the plan sponsor pays future premiums and (as prescribed under IRC 419) only the calculated portion of the premium is the deduction, where the calculated portion includes the amount of premium for one year's of life insurance coverage and for pre-funding the other post retirement medical benefits to be provided by the life insurance cash value at retirement?

This being considered as an alternative to implementing an additional policy.

Thanks.

[Guest San Diego Benefits Guy]

Say a client sponsors a VEBA plan and decides that they want to fund some of the benefits with life insurance.

For one of the participants they want to purchase a poplicy with a face amount of say $1 million.

The participant already has life insurance with a face of $1 million.

Could this policy become part of the plan where the plan sponsor pays future premiums and (as prescribed under IRC 419) only the calculated portion of the premium is the deduction, where the calculated portion includes the amount of premium for one year's of life insurance coverage and for pre-funding the other post retirement medical benefits to be provided by the life insurance cash value at retirement?

This being considered as an alternative to implementing an additional policy.

Thanks.

Gary:

Your proposal might be possible. PTE 92-5 sets forth a class execption that permits the transfer of certain individual insurance or annuity contracts by plan participants or employers to certain employee benefit plans. The class exemption provides, in part, that the plan pay, transfer or otherwise exchange no more than the lesser of the cash surrender value of the contract. It appears that the contract could be transferred with no consideration being paid. I believe that a welfare benefit plan is treated as an "employee benefit plan" under ERISA Section 3(3). Ed

[Don Levit]

Gary:

Are you saying that the life insurance policy will be used either to pay a death benefit before retirement, or to pay medical benefits after retirement, but not used for both benefits for the participants?

Don Levit

[Gary]

Don,

It will be for both.

Of course if there is a death then the death benefit will go to the beneficiary and there will be no further benefits from the plan on account of this participant.

Thanks.

[Don Levit]

Gary:

I don't think this will agree with the IRS's viewpoint.

The combination of the availability of trust funds to pay medical expenses, and the resudual payment upon death suggest that the trust is in effect operating as a permanent wealth-building vehicle. Such a payment upon death is not a permissible VEBA benefit.

Go to:

http://www.irs.gov/pub/irs-tege/eotopicf99.pdf.

Don Levit

[Gary]

Thanks for the link Don.

To clarify the trust is essentially for medical benefits for participants for whom no life insurance policy is used for funding (no death benefit for those participants) and the life insurance will essentially be funding the medical and death benefits for the participants with life insurance.

Though, providing death benefits for 2 HCEs and not for the three NHCEs is likely discriminatory under a VEBA.

[Don Levit]

Gary:

Are you saying that the death benefits are providing the medical benefits, and that you are not using the cash available before death for medical benefits?

Don Levit

[vebaguru]

There is nothing inherently wrong with the approach Gary suggests. However, as he points out, it is likely discriminatory, not only as a VEBA, but as a medical plan under IRC 105 and as a death benefit provided under IRC Section 79.

Moreover, "future" death benefit costs are not permitted under IRC 419, and under IRC 419A are limited to funding a paid-up life insurance benefit of $50,000 at retirement, funded in equal annual installments over the participant's working lifetime.

The VEBA article referenced is quite outdated, predating the potentially abusive tax shelter rules, IRC Section 409A, the 419A(f)(6) Regs, etc.

[Don Levit]

vebaguru:

Are you saying that a life insurance policy could utilize the cash values to help pay meducal benefits for a participant, and, in addition, be used to pay death benefits to his beneficiary?

If that is so, then please cite a specific federal code section in which this is allowed, to contrast that with the "outdated" article.

Don Levit

[vebaguru]

The HRA Regs include life insurance as a permissible benefit within an HRA. See Notice 2002-45 and RR 2002-41.

[Don Levit]

Vebaguru:

I looked over both of those citations.

While the ruling and the notice emphasize the HRA can be used only to reimburse medical expenses, I did find a section that was somewhat interesting in Notice 2002-45.

"An HRA does not qualify for the exclusion under 105(b) if one has the right to receive cash or any other benefit other than the reimbursement of medical care expenses. If any one has such a right currently or for any future year, all distributions made are included in gross income, even amounts paid to reimburse medical care expenses. For example if it pays a death benefit without regard to medical care expenses, no amounts paid are reimbursements paid for medical care expenses excluded under 105(b)."

So, are you saying that if the HRA pays a death benefit with regard to medical care expenses, then this would be kosher?

An interesting take on this portion.

Why do you mention this in regard to VEBAs?

If the VEBA, for example, paid the hospital after the participant's death, this would not be a death benefit.

Rather, it would be a medical benefit paid after one dies.

Don Levit

[vebaguru]

Under Notice 2002-45 HRAs are almost totally defined HRAs in terms of comparison and contrast with FSAs under section 125. Both incorporate the definition of medical expenses under 213(d), and HRAs are referred over to the rules published under IRC section 125 for specific items of medical expenses eligible for reimbursement.

Inclusion of life insurance under a 125 plan (and by extension, under an HRA) is addressed in 1.125-2T, Q&A1 of the temporary Regs.

Regs. have the force of law, at least if upheld by a court when challenged. Outdated, informal, internal training materials published by IRS do not.

[Don Levit]

vebaguru:

We know from the information you cited that HRAs can only be used to pay for medical expenses.

If used for any other expense, the tax benefits would be eliminated.

I find this rationale works very similarly to a VEBA which has a sub account for medical expenses.

You say that some of the 1999 EO CPE Text from the IRS is out of date.

Is this portion out of date: "Upon retirementy funds in the employee's account must be used for certain specified purposes, usually medical insurance premiums and medical expenses not covered by insurance. If the employee dies before his account is depleted, remaining funds are paid to a designated beneficiary.

Although viewed in isolation the benefits provided by such a trust may appear to be permissible VEBA benefits (a permissible medical benefit plus a death benefit), the combination of funds to pay current health insurance premiums and the residual payment uppon death suggests that the trust is operating as a permanent wealth-building vehicle. Any amounts not used to pay health insurance premiums during the lifetimes of the participant and his spouse would eventually be paid to beneficiaries. Such a payment upon death is not a permissible VEBA benefit. There is no current protection, no insurance-type protection, and no set death benefit."

To view, go to:

http://www.irs.gov/pub/irs-tege/eotopicf99.pdf.

See p. 109.

Don Levit

[vebaguru]

As I previously noted, opinions former IRS employees are not relevant. For the correct citation, go here: Regs 1.125. This is IRS' official view of the matter.

[Don Levit]

vebaguru:

I looked over the regulation before I responded.

Can you cite the particular words in the regulation which says that a trust dedicated to paying medical benefits can pay death benefits if a participant has a balance in his account when he, his spouse, and his dependents have died.

Don Levit

[vebaguru]

Quoted directly from the Reg.: "Thus, a cafeteria plan may offer coverage under a group-term life insurance plan of up to $50,000 (section 79), coverage under an accident or health plan (sections 105 and 106), coverage under a qualified group legal services plan (section 120), coverage under a dependent care assistance program (section 129), and participation in a qualified cash or deferred arrangement that is part of a profit-sharing or stock bonus plan (section 401(k)). In addition, a cafeteria plan may offer group-term life insurance coverage which is includable in gross income only because it is in excess of $50,000 or is on the lives of the participant's spouse and/or children. In addition, a cafeteria plan may offer participants the opportunity to purchase, with after-tax employee contributions, coverage under a group-term life insurance plan (section 79) * * *."

This means that a flex plan (and also an HRA) can provide life insurance of $50,000 or more. It has nothing to do with "a balance in his account" or whether "his spouse, and his dependents have died". It has to do with whether he used funds in his account to purchase life insurance, as permitted in this Reg. If the funds are held in an insurance policy that meets the requirements of Section 79, they will be distributed to the named beneficiary on death.

[Don Levit]

vebaguru:

I agree that a cafeteria plan can include a section 79 life insurance policy that is paid to the beneficiary upon the participant's death.

However, this policy does not include a cash value that can pay medical expenses during the participant's life, correct?

Don Levit

[vebaguru]

A section 79 death benefit can be funded with term or permanent insurance, and with individual or group policies (See 1.79 of the Regs.). The death benefit portion of the policy is separate from the investment portion of the policy. Since medical accumulations are subject to UBIT within a VEBA, it only makes sense to make excess premium payments into a permanent life insurance contract and use the polict's tax-free inside buildup feature. (Note: annuities don't provide tax-free inside buildup inside a welfare benefit plan.)

Note that the life insurance policy is permissible inside an HRA, and is part of the HRA. By funding the health accumulation amounts inside the policy, you have accomplished 2 purposes: (1) achieved a distribution of the entire benefit upon death, and (2) avoided UBIT.