Health Insurance premiums after termination of employment

[Belgarath]

Since I am brought in only tangentially on cafeteria plans, I'd love to hear any opinions on the following question that came up:

We recently offered an early retirement program to a select group of employees. As part of that program, if the employee accepts they can receive (XXX) in a lump sum and health care plan continuation for up to 24 months. One of the questions that has come up is if they can have deducted from that lump sum future health care premiums. As premium deductions are made through the Section 125 plan, can this be done?

It seems to me that perhaps it is possible for 2013, but not for 2014? In other words, the proposed 125-1 regulations require that all participants must be employees. It further defines an "employee" as including former employees, and (g)(3) limits participation by former employees in that the plan may not be established primarily to benefit former employees.

So it would perhaps seem possible to do it in the first year (2013) but it doesn't seem allowable for any future year (2014) under 1.125-1(p)(ii)(A)?

I'd appreciate any thoughts on this. As you can see, I don't know much about this subject! Thanks.

[GMK]

I don't think this will fly.

A section 125 plan allows an employer to offer employees the choice between receiving their compensation from the employer in cash or a non-taxable benefit, like paying health coverage premiums with pre-tax dollars.

Once the employees retire and receive their lump sum, there's no more cash coming from the employer to the employees, so there's no more choice of cash or benefit. A portion of the lump sum could probably be run through the 125 to pay the current premium pre-tax, because the lump sum is part of their compensation. But after that, I think no. It's like not being able to run payments from a pension through the 125 to pay premiums pre-tax.

But others may have a different take on it.

[Belgarath]

Thanks - I was assuming 1 annual premium paid in a lump sum, but I forgot to specify that. I was thinking along the same lines as you with regard to the ongoing premiums.

Ok, after thinking about this, I think I misunderstood your point. So let's say these are monthly premiums, and employee currently has an election in place for 2013. I think you are saying that since there is no paycheck from which to withhold such premiums, that this won't work.

That makes sense. You might, perhaps, be able to get away with a month's premium, using the logic in (p)(5)(i)?

[masteff]

If nothing else, salary reductions are subject to the annual "use it or lose it" rule, so 125 would be the wrong way to fund beyond the end of the current year. Although you could probably set up a VEBA but I only know enough on those to be dangerous to all parties involved.

if the employee accepts they can receive (XXX) in a lump sum and health care plan continuation for up to 24 months. One of the questions that has come up is if they can have deducted from that lump sum future health care premiums.

I think they're half way down the wrong road. IRS Pub 15-B, page 7, Cobra premiums are excludable from income whether the company pays them directly or reimburses the former employee for premiums paid. While Cobra is generally shorter than 24 months, I believe it's safe to extrapolate the Service's postion to 24 months; they're no less former employees in month #24 than they were in month #18. http://www.thompson.com/public/headlines.jsp?id=46

And I'm a little confused because what you quoted first mentions continuation coverage, so is the deduction from the lump sum for that continuation coverage or for some other coverage? If it's for the contination coverage, see immediately above. If for something else, then I'm confused on for what.

Side thought: if it's an insured plan, the insurer might not permit more than mandatory Cobra, so months beyond that might get messy.