Gov't agency VEBA for retiree medical

[Guest Penelope]

A client is considering participating in CALGOVEBA, a multi-employer trust that allows participating agencies to maintain separate asset pools to pay retiree health premiums and to reimburse medical expenses of retirees. The program provides for employer contributions and for pre-tax employee contributions that are described as "mandatory," because they are required pursuant to collective bargaining agreements (MOUs). So far, so good.

However, CALGOVEBA has advised employers that the MOUs may require a minimum pre-tax payment of all bargaining unit members and permit members to elect to make pre-tax contributions at a higher level of contribution. Their position apparently is that since pre-tax contributions in general are required by the MOU, permitting individuals to choose higher contributions does not create a problem of individual choice under section 105.

The VEBA has a favorable ruling on its tax status under section 501©(9). It does not have a ruling on the tax consequences to participants under section 105. My view is that offering individual bargaining unit members the chance to elect among various contribution levels results in inclusion of those higher contributions in taxable income.

Anyone have experience with CAGOVEBA or have any thoughts on my analysis? (I'd be happy to be wrong!)

[GBurns]

I am not sure I am understanding your concerns on what seems, to me, to be a quite commmon practice. I also wonder why your client would not want to use CALPERS or one of the other long established and proven entities.

What does "permitting individuals to choose higher contributions .." have to do with 105 ?

Why do you consider the taxation of the employee election to be a 105 issue rather than a section 125 issue ?

[Don Levit]

Penelope:

Are you asking whether the election to pay higher contributions is discrimimnatory?

My off the cuff answer would be no, as long as benefits vary in direct proportion to contributions made.

That is also assuming the contributions are considered employee contributions.

Don Levit

[Everett Moreland]

Penelope:

I agree with your concern. See IRS PLR 200837002 (9/12/2008), here http://www.irs.gov/pub/irs-wd/0837002.pdf

I think the individual election employee election would be after-tax, because an employee cannot fund a future retirement health benefit through a cafeteria plan.

[Don Levit]

Everett:

Why do you say that employees cannot fund a future retirement health benefit through a cafeteria plan?

Is this because you believe that medical benefits are a form of deferred compensation?

According to the IRS, VEBA funded cafeteria plan benefits are not necessarily inconsistent with exempt status under 501©(9).

See http://www.irs.gov/irm/part7/ch10s12.html.

Don Levit

[Guest Penelope]

Thank you all for your responses.

George Burns--this program is a supplement to coverage under the CALPERS medical plan, and is intended to help retirees pay for their share of CALPERS premiums as well as reimbursing them for out-of-pocket expenses. I should have been more precise in my description of the problem. My concern is that employees who make individual elections to contribute more than the minimum required by the MOU are making a choice between taxable pay and contributions to a health plan. This arrangement would not qualify as an HRA to the extent it permits salary reduction contributions elected on an individual basis. Because the arrangement allows participants to defer receipt of these benefits until retirement, it also would not satisfy section 125's prohibition on deferral of compensation. As a consequence, contributions greater than the minimum would not be excluded from income. You describe this arrangement as a common practice--do the programs you have seen allow employees to carry over their contributions for years until retirement?

Don Leavit--it's not discrimination I'm concerned about, but the element of individual choice. The administrators of the program say that all the salary reductions are "mandatory" under the proposed MOU, and are therefore considered to be employer contributions for purposes of the HRA requirements. However, I think only the minimum contributions required under the MOU are mandatory. If an employee can chose whether or not to make additional contributions, I'd say those additional contributions are not mandatory, but voluntary.

Everett Moreland--thanks for the citation!

Here's another question that just occurred to me--if the addition non-mandatory contributions are withheld from pay on an after-tax basis and held in an account that accumulates earnings, will distributions from the earnings to reimburse medical expenses be excluded from income under section 105? If so, and if we ever return to an era of investment gains, it might be worthwhile to let employees contribute to this program on an after-tax basis.

[Don Levit]

Penelope:

I would agree with you that the contributions are voluntary, and not mandatory.

The question is would the benefits defer compensation, and thus not be available through section 125.

One of the exceptions to deferred compensation in cafeteria plans is health savings accounts.

Bear in mind that money in an HSA can be surrendered without having a medical expense, although a penalty may apply.

With an individual savings account in a VEBA, the money can be used only for medical expenses.

Those dollars remaining at death go back to the VEBA.

So, it is my contention that dollars in a post-retirement medical savings account in a VEBA would also apply for an exception to the deferred compensation plans in a cafeteria plan, although not specifically enumerated.

The growth of the medical savings account would also be excludable from tax, for they must be used only for medical expenses, and cannot be surrendered merely due to the passage of time.

Don Levit

[Guest Penelope]

Don:

I don't think the HSA theory will work here because these retirees will be not be covered by a high-deductible health plan. If the proposed arrangement isn't an HSA the section 125 ban on deferred compensation would apply.

[Everett Moreland]

Everett:

Why do you say that employees cannot fund a future retirement health benefit through a cafeteria plan?

Is this because you believe that medical benefits are a form of deferred compensation?

Don: Yes, I think that retiree health benefits are deferred compensation for purposes of the cafeteria plan rules.

[Don Levit]

Everett:

I can see where you would come to that conclusion.

One could say that compensation is deferred, for the benefits are not payable in the current year.

I believe there is also a basis for coming to the opposite conclusion.

As you know, VEBAs are not intended to provide deferred compensation either.

This is why profit-sharing and other retirement plans are forbidden, because these benefits are definitely payable, and accrue due to the passage of time.

However, while retirement health benefits accrue over time, they are payable only upon a contingency, i.e., a medical claim.

PLR 9323006 may be helpful.

"School District D decided that instead of paying cash to its employees for their unused sick leave, it would contribute such amounts to a VEBA Trust to provide to its employees and retirees, supplemental medical benefits."

"Rev. Rul. 75-539 provided that an employee, upon retirement could choose either to receive a cash payment for accumulated sick leave or to have such payment applied to the cost of such insurance.

This ruling held that if the employer places the value of unused accumulated sick leave credits in escrow solely for the payment of healh insurance premiums and the plan provides that such credit may not in any event be received in cash by the employee, his spouse, or dependents , then such amounts are not constructively received by the employee."

"An eligible or retiring employee has no choice regarding whether his employer will pay out his sick leave credit in cash or in supplemental health benefits."

"D's contribution to the VEBA Trust is not taxable under the constructive receipt doctrine of section 451, and payments from the VEBA will not be taxable to the employee except to the extent it constitutes excess reimbursement under section 105(h)."

If the employee makes payments for retiree health benefits, instead of receiving the money in salary,

and he cannot receive this money other than by having a medical claim (no surrender value), and he never has constructive receipt, then why are not his contributions deductible under a cafeteria plan?

Don Levit

[Everett Moreland]

Don: I think that the following proposed 1.125-1(b)(5) indicates that retiree health benefits are deferred compensation for purposes of the cafeteria plan rules:

"(5) No deferred compensation. Except as provided in paragraph (o) of this section, in order for a plan to be a cafeteria plan, the qualified benefits and the permitted taxable benefits offered through the cafeteria plan must not defer compensation. For example, a cafeteria plan may not provide for retirement health benefits for current employees beyond the current plan year or group-term life insurance with a permanent benefit, as defined under § 1.79–0."

[GBurns]

Hasn't 1.125-1 been repealed and replaced ? What do the new Proposed Treas Regs now say about the issue ?

The IRS has opined in many PLRs that not being able to cash out or have a choice of cash, makes it not be deferred compensation.

In any case it seems that pre-tax contributions cannot be made to a VEBA for pre-funding retiree health benefits according to what i have always heard. I suggest doing a Google search using the phrase "employee funding retiree health". You will see a number of links either addressing the issue or linking to existing VEBAs used for retiree health benefits. Those should shed some light n the issue for you.

[Don Levit]

Everett:

Is there any way you could send me the link to the proposed regulations?

George:

I have always wondered why the "experts" say there are no ways to pre-fund retiree health liabilities through a VEBA, via employee contributions.

We know there are no account limits for employee-pay-all VEBAs.

Maybe the reason that is so, is because the contributions must be after-tax.

I have read many times articles referring to employee contributions being after-tax.

But, I have seen no guidance to that effect...until Everett provided the proposed regulation.

If it has been repealed, then I think we're still in the ball game.

If not, we can look to Penelope's post with after-tax employee contributions.

Or, there is still the traditional employer contributions according to 419A.

Are we in agreement that the interest accruing for proper set-asides for medical expenses are not subject to taxation, either through income tax or UBTI?

In addition, are we in agreement that interest on individual medical savings accounts via after-tax employee contributions are not subject to income tax or UBTI?

Don Levit

[Everett Moreland]

Don: The regulation was proposed in the Federal Register on 8/6/07 and has not (so far as I know) been withdrawn. The link is here http://edocket.access.gpo.gov/2007/pdf/E7-14827.pdf

[Don Levit]

Everett:

Thanks for the link.

It does look like paying for retiree health insurance premiums would be disallowed.

What about the scenario in which the VEBA provides current benefits, and upon leaving the employer, the employee takes the plan and continues paying premiums to the VEBA at the new employer, or simply retires, but continues paying premiums?

Don Levit

[Everett Moreland]

Don: Your question goes much beyond what I know about VEBAs.

[Don Levit]

Everett:

While it seems there are restrictions on using the cafeteria plan to pay for retiree health benefits, there is an opportunity to provide current benefits, that if not used, could be "rolled over" at a new employer, or could be utilized as a former employee, if self employed or retired.

Former employees, whether "retired" or not, can continue as part of the VEBA.

Don Levit