VEBA versus IRC Section 115 Trust for Municipality

[Guest Patriot190]

A municipality is considering establishing a VEBA to fund future (10 - 20 years out) postretirement benefits. What factors should be considered in determining whether a VEBA or IRC Sect 115 Trust would be best for a municipality? Is the only significant difference between the two the 'reversion to employer' aspect of the Sect 115?

Any expert input is very much appreciated. Thanks in advance.

[Everett Moreland]

http://benefitslink.com/boards/index.php?showtopic=32100

[Don Levit]

Everett:

Thanks for providing that link.

One of the respondents mentioned that earnings on trust assets are taxable as unrelated business income (UBIT). As I understand UBIT in VEBAs, if the amount set aside is within the limits, there is no UBIT.

I don't know much about Section 115 trusts, but I do believe that increases in health care costs are allowed in the pre-funding.

This is not allowed in VEBAs.

Don Levit

[vebaguru]

I don't know much about Section 115 trusts, but I do believe that increases in health care costs are allowed in the pre-funding.

This is not allowed in VEBAs.

Nothing in Section 501©(9) prohibits funding of increases in health care costs. The limitation that you are referring to (I believe) is found in IRC Section 419A and limits tax deductions to the amount required to fund current benefit levels over the working lifetimes of the participants. THIS DOES NOT APPLY TO TAX-EXEMPT EMPLOYERS whether funding a 115 trust or a 501©(9) trust.

[Guest HarborLights]

A municipality is considering establishing a VEBA to fund future (10 - 20 years out) postretirement benefits. What factors should be considered in determining whether a VEBA or IRC Sect 115 Trust would be best for a municipality? Is the only significant difference between the two the 'reversion to employer' aspect of the Sect 115?

Any expert input is very much appreciated. Thanks in advance.

Our local govt agency is looking into VEBAs versus a Sect 115 Trust. My limited understanding (which could be wrong), is that Sect 115 Trust is limited to cash type investments. So no ability to take advantage of stock market returns. I am under the assumption (also may be wrong) that VEBAs have no such limitation. However, VEBA assets may not revert to the employer. So who receives the funds if the Trust becomes over-funded, and all benefit liabilities have been paid? An example would be if we set up a trust for current employees only, excluding future hires after say 2010, and then benefits paid were for a period certain, say for 1/2 the time served. So an employee with 20 years of service would receive 10 years of benefits.

Have you found an expert that has been able to assist you in this manor?

[Don Levit]

HarborLights:

I am curious if your particular state limits 115 investments to cash-type investments.

It doesn't appear to be part of the federal code.

Upon termination of the VEBA, any assets remaining after satisfying all liabilities, are applied to provide other benefits , as long as they are not applied disproportionatly.

The amount distributed can be set by a collective bargaining agreement , or on the basis of objective and reasonable standards which do not result in unequal payments to similarly situated members.

Treas. Reg. 1.501©(9)-4(d).

Don Levit

[GBurns]

HarborLights

You might want to check and see if there are any small governmental agencies that have ever successfully enjoyed "stock market returns" on their portfolio, or have successfully invested in the stoock market or equities. In fact, I doubt that you can even find many large ones aside from the ultra supersized who have large investment management teams eg NYC, NYState, CALPERS etc

[Don Levit]

vebaguru:

Your response stating that deductions are limited to the amounts needed to fund the current benefits over the working lifetimes of the participants is correct.

You have stated before that additional funding can be made, but it will not be deductible.

Will the earnings of that additional funding be taxable?

Don Levit

[vebaguru]

If we are still talking about a plan maintained by a municipal government, the earnings on the "excess" (at least they would be excess if section 419 applied) contributions are not taxable, whether those are held in a 115 trust or in a VEBA.

[Don Levit]

vebaguru:

Thanks for your reply.

Sounds like your answer would differ if the plan was not maintained by a municipal government.

That is where my question is directed.

Would these earnings for excessive contributions be tax exempt, even if invested in tax-exempt vehicles?

Don Levit

[vebaguru]

Earnings inside a 115 trust are taxed to the grantor, a tax-exempt municipality.

Your question seems to be whether excess earnings are still excess earnings if they are tax-exempt?

The answer is yes they are still excess earnings and will reduce the tax deduction permitted under section 419. However, they are not taxable.

[Don Levit]

vebaguru:

Are the excess earnings ever taxable as UBTI in a VEBA for a private employer, even if the earnings are tax-exempt?

I say yes; you seem to say no.

I can provide the IRS citation.

Don Levit

[Guest HarborLights]

HarborLights

You might want to check and see if there are any small governmental agencies that have ever successfully enjoyed "stock market returns" on their portfolio, or have successfully invested in the stoock market or equities. In fact, I doubt that you can even find many large ones aside from the ultra supersized who have large investment management teams eg NYC, NYState, CALPERS etc

Dear G Burns-

As a municipality or govt agency, the issue has to do with whether the assets are truly "segregated" from General Fund Reserves. My understanding is that a 115 Trust is not truly segregated (i.e., Irrevocable), and therefore must be invested in General Fund type vehicles, which are limited to Cash or Cash Equivalent type investments (<5 years...investment grade bills and notes). I have only learned this from a conference. It was an "expert's" opinion. I can't say whether or why this is true.

CalPers is an irrevocable trust. So they are able to invest in the stock market.

[Guest HarborLights]

HarborLights:

I am curious if your particular state limits 115 investments to cash-type investments.

It doesn't appear to be part of the federal code.

Upon termination of the VEBA, any assets remaining after satisfying all liabilities, are applied to provide other benefits , as long as they are not applied disproportionatly.

The amount distributed can be set by a collective bargaining agreement , or on the basis of objective and reasonable standards which do not result in unequal payments to similarly situated members.

Treas. Reg. 1.501©(9)-4(d).

Don Levit

Dear Don-

What we want is the ability to bring excess assets BACK INTO THE GENERAL FUND AS CASH. As a municipality, of course these assets can be used for other things. But if the fund grows to $16MM, and our current employee benefits for the other employees not in the VEBA are costing $1MM, what happens to the other $15MM?

I have no interest in giving $1MM each to the original 15 participants in the original pool; nor do I care to commit the assets to future employees.

The idea is to ensure that the liabilities of the original 15 participants are fully funded, not excess funded. That's what I am trying to avoid.

[vebaguru]

That is one of the primary advantages of a Sec 115 trust over a VEBA. Of course the employees DON'T want the employer to be able to take money back that was set aside for them, and when they are represented will negotiate hard for the use of a VEBA to avoid such reversions.

[Don Levit]

vebaguru:

You wrote that excess earnings are not taxable, if invested in tax-exempt vehicles.

Then how would you explain Treasury Regulation 1.512(b), which states "the unrelated business taxable income of a VEBA will equal the lesser of two amounts: the income of the VEBA; or the excess of the total amount set aside ."

How do you have excessive income?

One would think by having an excessive amount set aside.

If that is the case, then the income of the VEBA, even if non taxable, is subject to UBTI, if the income is less than the excessive amount set aside.

Don Levit

[vebaguru]

Answered on the other thread.

[Don Levit]

vebaguru:

I didn't understand your answer.

Can you provide an excerpt from a specific code section to elucidate youir point?

Don Levit

[GBurns]

Don

In post #16 you asked "How do you have excessive income?"

What does that have to do with your quote of 1.512(b) ? Where did you get the term "excessive income" ?

[Don Levit]

George:

Good point. Excessive income is not totally accurate.

What I meant to say is income generated by an excessive amount set aside, an amount set aside exceeding section 419A.

Don Levit

[GBurns]

Then you need no cite, logic should suffice.

If the amount set aside is excessive, then any addition would only increase the amount of excessiveness and therefore be afforded the same treatment as the initial excessive set aside amount.

[vebaguru]

Or as Geo W Bush would say it, the "amount of excessivicity".

[Guest VEBAPLAN]

A municipality is considering establishing a VEBA to fund future (10 - 20 years out) postretirement benefits. What factors should be considered in determining whether a VEBA or IRC Sect 115 Trust would be best for a municipality? Is the only significant difference between the two the 'reversion to employer' aspect of the Sect 115?

Any expert input is very much appreciated. Thanks in advance.

[J Simmons]

Thanks VEBAPLAN for repeatedly posting your two authored pieces. It wasn't until about the third time I read each of them that I realized that I was re-reading the same piece. But I kept re-reading each, as many times as you posted it. Being so slow witted and all, I appreciate all the multiple postings. It wouldn't have occurred to me that I could re-read a single posting of them, in one forum under one thread!

[Don Levit]

John:

Don't be such a scrooge.

Why provide positive reinforcement?

Don Levit