Salary "Redirection"

[Guest ehs]

A school has salary contracts for all employees. The contract states the annual salary the employee will recieve. Employer has a Section 125 Plan. Employer tells employees if they want to participate in the Section 125 plan, the salary stipulated in the contract will be reduced by the elected amount, and whatever remains is their regular compensation paid out over the course of 12-months. The elected amount is essentially taken before the wages are a function of pay. This looks like an employer contribution to me, which I don't think is a problem, but why am I uncomfortable with the set up?

[QDROphile]

Assuming that the elections comply with section 125 (e.g. timing), this sounds like a typical section 125 arrangement. For tax purposes, all section 125 plans work on the basis of employer contributions, so I don't understand any implications of your remark about employer contributions.

The more interesting question is whether or not the elected amounts will reduce compensation for purposes of retirement or other benefits. The usual approach is that the reductions do not reduce compensation for retirement plan purposes, but that is a matter of plan design.

[Guest ehs]

I agree with your comment about the "employer contributions", it is the way the client makes those contributions that is troubling me. For example, if my contract says the school will pay me $40,000 and I elect to allocate $1000 to my FSA, the school will subtract $1000 from my contracted pay amount of $40,000 and tell payroll that my annual salary is $39,000. They are eliminating their risk with the FSA as well. So the $1000 is never a function payroll. It is just weird, and I may be overthinking it. Yes?

[LRDG]

I've experienced first hand some interesting interpertatins on the topic of Sec. 125 salary reductions and reducing teacher salary contracts, particularly in private school settings. There is no reason to do this, and many reasons not to. Retirement plans, Disability income, life insurance are all salary based and it's possible for teachers to experience reductions in these benefits.

Also, the answer depends on what happens when new salary contracts are drawn up next year, or 5 yrs down the road when there are new salary administrators unaware of the reduced salary contract, and decide the school will no longer 'pay' for the benefits.

[QDROphile]

How is employer risk eliminated?

[Guest ehs]

How is employer risk eliminated?

Because the employer is taking the entire annual election from the contracted salary amount. Rather than "paying" or compensating the participant $40,000 (for example) the $1000 election (for example) is subtracted from the contracted compensation and the bi-weekly rate of pay is now $39,000/26. The $1000 that was budgeted for the participant is now expensed to the FSA. So the employer is now not waiting until plan year end for the participant to fulfill its election comitment, they have it all upfront!

[QDROphile]

Are you a math teacher?

[Guest ehs]

Are you a math teacher?

Far, far from it. Why? Is there an error in my explanation?

[QDROphile]

Assume a $49,200 annual pay and election of $1,200 under the health FSA.

The coverage is $1,200, beginning on the first day of the plan year. Each month the employee's pay is $4,100 (49,200/12), but the reduction for the month of $100 for the FSA means that the taxable pay is $4000. If the employee has $1200 in expenses in January and quits at the end of the month, the employer has an experience "loss" of $1100.

Assume annual pay of $49,200, reduced by $1,200 for the year for the FSA. The coverage is $1,200. The employee's taxable pay is now $4000 per month ($48,000/12). If the employee has $1,200 in expenses in January and quits at the end of the month, how is the effect on the employer or employee any different?

You can cut the pay into smaller pay periods, but the result is the same. The employer is obligated for the full amount of the health FSA coverage during the entire coverage period. The employer does not "have" anything up front as long as the employee is only paid for work performed in a pay period.

[LRDG]

Minus the payroll function, it doesn't sound like a Sec. 125 plan.

How are FSA's funded and how are Medical/DC FSA expenses paid?

[Guest ehs]

Minus the payroll function, it doesn't sound like a Sec. 125 plan.

How are FSA's funded and how are Medical/DC FSA expenses paid?

The employee for go's a portion of salary equal to the total non-taxable benefits elected. The annual elected amount for all benefits is essentially deposited into a "bucket", or several "buckets" each labelled a particular benefit (i.e., health insurance, dental insurance, HCFSA, DCAP, etc.). As we all know the health FSA is funded immediately, that is the risk. Normally, the employee fulfills the elected amount by the time the plan year ends, through payroll deductions. In this case, there are no payroll deductions throughout the year, because the employer has already set aside the portion of pay equal to the benefits elected for the year. No payroll reporting is required, because what is elected at the beginning of the year is the only payroll deduction that will occur.

Make sense?

[LRDG]

I'm familiar with the concept of establishing accounts for various benefits, some of which are funded, other accounts operate as an accounting function only, for instance insurance premiums paid pre tax are accounted for under Sec. 125, but the funds are actually paid to the insurance carrier.

Health FSA annual elected amounts are made available, but are not typically funded immediately.

DOL has issued a negative opinion on this type of arrangement. Not specifically with regard to Sec. 125, because the employer organization that attempted to engage in this practice with employees did so years before IRS wrote Sec. 125 into the tax code.

If this type of arrangment were legal, 'we' would have no need for written PDs, SPDs, salary reduction agreements, etc.

[QDROphile]

I am very skeptical about the claim that the FSA is funded immediately, except as a budget function. Even if it is, government plans are not subject to ERISA and the plan asset rules do not apply. I think you are fussing about form over substance when it comes to characterization of the election. As previous posts have indicated, the concern should be whether or not salary is reduced for puposes of other benefits that are measured by salary.

[LRDG]

In lieu of a salary increase, a close relative agreed to reduce a salary contract by an amount equal to the cost of health and dental premiums. Five years later the new salary administrator/parish priest, advised that the parish could no longer "pay" for benefits.

School boards are very political entities, particularly when it involves benefits and salaries. I doubt salary reduction contracts of this type are administered by a public school board.

[Jacmo]

Seems to me that this is just a typical 125 plan. But I would be curious to see the Plan Doc. and SPD (or whatever they have in writing).

[Don Levit]

If the salary reductions for a government entity were to pay for retiree health benefits, would there be any ramifications?

Apparently, in this scenario, the health benefits were "current" benefits.

Also, would there be any difference in the "strength" of the state's obligation, if the salary reduction was actually made, as opposed to an "oral agreement?"

Don Levit

[LRDG]

"Seems to me that this is just a typical 125 plan. But I would be curious to see the Plan Doc. and SPD (or whatever they have in writing)."

Jacmo, it seems to be an attempt to avoid establishing a Sec. 125, and possibly to reduce compensation based benefits, payroll taxes, WC premiums.

Don Levit, I'm assuming it's not a govt. entity/plan, and no salary reduction agreements. (Regretably more supositions than brain cells can manage this morning.)

[QDROphile]

How is the description of the plan inconsistent with section 125? We don't have much detail, but there is nothing I see except concern because of use of annual amounts to describe the election. I provided a numerical demonstration on that point and no one has identified anything that is out of line.

[GBurns]

In my humble opinion, this seems like a very typical section 125 plan. However, I am concerned by how the OP describes the arrangement and I suspect that the payroll dept is not told that the employee's salary is $39,000 rather than $40,000. I suspect that the OP has this opinion as a result of having been given a simplistic explanation by someone trying to help.

Although, the OP does seem positive that there are no payroll salary reductions, but I still wonder.

Aside from whether or not section 125 is an issue, this seems exactly the same as in Express Oil Change and other such cases where the Courts decided that a section 125 plan was not needed to do this.