VEBAs and 419 Plans
VEBAs potentially provide a triple tax benefit: (i) contributions to a legitimate VEBA or other
welfare benefit plan may be tax-deductible within the limitations of Sections 419 and 419A of
the Internal Revenue Code (IRC), as actuarially determined; (ii) investment income may
accumulate tax-deferred inside a VEBA; and (iii) benefits paid from the VEBA can be
distributed income tax free, either as death proceeds of life insurance (under IRC section 101(a))
or for health reimbursement arrangement benefits under IRC section 105(h).
VEBA
A voluntary employees’ beneficiary association (VEBA) under Internal Revenue Code Section
501(c)(9) is an organization organized to pay life, sickness, accident, and similar benefits to
members or their dependents, or designated beneficiaries. The organization must meet the
following requirements:
1. It must be a voluntary association of employees;
2. The organization must provide for payment of life, sickness, accident, or other benefits to
members or their dependents or designated beneficiaries and substantially all of its
operations must be for this purpose; and
3. Its earnings may not inure to the benefit of any private individual or shareholder other
than through the payment of benefits described in (2) above.
VEBAs may be used to provide benefits for businesses of all sizes. General Motors and many
other large companies use VEBAs for benefits. Municipalities, police, and fire departments also
sometimes use VEBAS for health and welfare benefits. If done correctly, some small businesses
can also benefit from a VEBA. The contribution is a tax deduction and money can come out tax
free for qualified benefits. Below is information summarized from a typical VEBA trust that
also intends that the plan meet the requirements of IRC Sections 79, 105, 419, 419A, and 505.
This type of VEBA would most commonly be utilized by a small profitable business or
incorporated professional such as a doctor.
Taxability of Trust Net Income
VEBA trusts are exempt from Federal income taxes under IRC Section 501(c)(9). However, to
the extent that the VEBA is used to accumulate retiree medical benefits, it may be subject to
Unrelated Business Income Tax under IRC §512(a)(3). The author recommends that VEBAs
used to provide retiree medical benefits or health reimbursement benefits that carry over from
year to year invest in tax-exempt or tax-favored investments, such as life insurance contracts,
municipal bond funds, etc.
Taxability of Plan Benefits to Participants and Beneficiaries
• Group-term life insurance benefit – The death proceeds of life insurance policies to a
participant’s named beneficiary are paid tax-free to the beneficiary, as provided in IRC
§101(a).
• Pre-retirement disability benefit – Disability benefits paid under a disability income
policy held by the trust are taxable to the participant under IRC §105(a).
• Post-retirement medical benefit – Amounts used to pay or reimburse medical benefits are
tax-exempt under IRC §105. Amounts used for payment of retiree medical premiums are
tax-exempt to the participant under IRC §106.
• Health reimbursement arrangement benefit – Amounts used to pay or reimburse medical
benefits are tax-exempt under IRC §105. Amounts used for payment of retiree medical
premiums are tax-exempt to the participant under IRC §106.
Taxability of Excess Benefits
The 100% tax on excess benefits imposed under IRC §4976 does not apply to a legitimate VEBA
by virtue of the plan’s compliance with the nondiscrimination requirements of IRC §505.
Group-Term Life Insurance Plan
A legitimate VEBA has always been able to provide a “group-term life insurance plan” within
the meaning of IRC §79 although Revenue Ruling 2007-65 has cast some doubt on this. The
amount of death benefit provided is typically a uniform multiple of each employee’s
compensation as permitted under IRC §79(d)(5), §505(b)(1) and Regs. §1.501(c)(9)-2(a)(ii)(F),
although tiered benefits may be used with groups of ten or more.
Contributions for current premiums or contributions represent a “qualified cost” and a “qualified
direct cost” within the meaning of §§419(c)(1) and (3) and as such are tax-deductible in the
current year. The amount of current “cost” or amount of premium charged by the plan for
insurance coverage should be actuarially calculated on the basis of a typical term insurance
policy, and the employer’s tax deductions are based upon that theoretical amount. Since most
plans provide for lifetime coverage, you can use a “term to 95” premium in actuarial
calculations.
The decision as to the type and amount of life insurance contracts to purchase to provide the
promised death benefit is an investment decision to be made by the plan’s fiduciaries. Research
and experience have shown that the net current cost of insurance can be obtained for less than a
theoretical term to age 95 policy if the plan purchases short-term term insurance (such as five- or
ten-year renewable and convertible) for those employees who terminate within five to seven
years of the issue date. Conversely, the overall cost of insurance is generally lower for those
employees whose policies continue in force for more than seven years if the plan purchases a
universal life or other permanent policy. However, such purchases generally result in spending
more in the early years of coverage.
Employees’ rights are not impacted by the decision to purchase one form of insurance or another.
All employees are entitled to the same benefits and rights under the plan, no matter which form
of life insurance has actually been purchased.
If the plan provides a post-retirement death benefit, the contribution to provide such benefit is
actuarially determined as the amount required to fund such benefit over the participant’s
remaining years of service on a level annual contribution basis, as required under IRC
§419A(c)(2), and an addition to the “qualified asset account” under IRC §419A(b). Such
contributions are therefore tax deductible within those limits. All post-retirement benefits are
done on a target basis, and are funded through separate accounts, thus fulfilling the requirement
of IRC §419A(d). All post-retirement benefits are paid from those separate accounts.
To the extent that the plan achieves a greater or lower net expense with respect to the purchase of
life insurance, an actuarial gain or loss will result. Actuarial gains result when the premium for a
policy obtained for a participant is lower than the theoretical premium for the term to 95 policy.
Actuarial losses may occur when an employee, for whom the plan purchased term insurance,
stays beyond seven years and the policy is converted to a universal life insurance contract at a
higher premium than would have been paid originally for the same contract. Similarly, an
actuarial gain will result when a cash value contract is purchased initially for a participant who
terminates before the cash value equals the sum of the premiums paid plus interest.
The trust is the owner of the policy and retains rights to it. Upon the death of a participant, the
death proceeds of life insurance, plus any policy cash value, will be forwarded to the trustee and
segregated into a separate account for the benefit of the participant’s beneficiary(ies). Therefore,
each participant must execute a designation of beneficiary form upon entry into the plan.
The cash values of the insurance policies are considered to be assets of the trust that are used for
funding the other benefits which may be provided under the plan, including a post-retirement
death (or medical) benefit. The administrator maintains an account for each participant.
Employer contributions to provide the promised benefit are credited to the account. The
theoretical cost of insurance coverage is deducted from the participant’s account. Each year
actuarial gains and losses, along with other gains and losses of the trust, are allocated among the
various members of the plan proportionate to their total interest in the trust.
Post-Retirement Medical Benefit
A legitimate VEBA provides a Post-Retirement Medical Benefit account that may be used by a
participant after his or her retirement for the purchase of health insurance or reimbursement of
out of pocket medical expenses. Such an arrangement may be considered a health
reimbursement plan described under IRC §105(h). The amount of benefit provided is a uniform
dollar amount, or a uniform dollar amount for each type of coverage.
The contribution to provide the post-retirement medical benefit is actuarially determined as the
amount required to fund such benefit over the participant’s remaining years of service on a level
annual contribution basis, as required under IRC §419A(c)(2), and is considered an addition to
the “qualified asset account” under IRC §419A(b). Such contributions are therefore tax
deductible within the limits provided. All post-retirement benefits are done on a target basis, and
are funded through separate accounts, thus fulfilling the requirement of IRC §419A(d). All postretirement
benefits are paid from those separate accounts.
Since no retiree medical advance payment policies are available in the marketplace, this amount
is funded through investment accounts. As noted above, generally net income on amounts used
to fund post-retirement medical benefits are taxable in the year earned. Frequently, clients elect
to invest such funds in tax-sheltered investments including life insurance policies and tax-exempt
mutual funds.
Medical benefits are limited to IRC §213(d) expenses.
A legitimate VEBA provides a Health Reimbursement Arrangement Benefit in accordance with
IRS Notice 2002-45 and Revenue Ruling 2002-41.
Contributions for such arrangements are tax-deductible, and benefit payments under such an
arrangement are tax-exempt.
The Participant may use his account for the purchase of health insurance or reimbursement of out
of pocket medical expenses. Such arrangements may be considered a medical expense
reimbursement plan described under IRC §105(h). The amount of disability benefit provided is a
non-discriminatory amount as provided under Regs. 1.105-11.
Voluntary Employees Beneficiary Association (VEBA) – Commentary
What on Earth is a VEBA? A voluntary employees beneficiary association is an IRS-approved,
tax-exempt trust used to fund employees’ welfare benefits such as health, life, and disability
insurance.
While VEBAs traditionally have been used by large corporations such as General Motors, if
structured properly, they may provide benefits for businesses of all sizes. They are also gaining
momentum among police and fire departments, for whom the trust has an inescapable logic.
GASB [Government Accounting Standards Board] rule changes are driving a VEBA revival. As
employers are compelled to put 30-year actuarial projections of their retiree benefit expenditures
on their balance sheets over the next five years, VEBAs will become attractive vehicles for
paying down that liability.
Some employers have a veritable VEBA already, unbeknownst to themselves. All they need do
is formally adopt into a VEBA trust and begin reaping the tax benefits. Some people have a
conservative view of how VEBAs should be used. Some use it very aggressively. It lends itself
to different types of applications and different employer scenarios.
Welfare Benefit Plans under Section 419(e)
Ideally, if operated as intended under the law, a legitimate 419(e) Plan or Single Employer
Welfare Benefit Plan would look like the following:
• The contribution to provide the post-retirement medical benefit is actuarially determined
as the amount required to fund such benefit over the participant’s remaining years of
service on a level annual contribution basis, and is considered an addition to the
“qualified asset account” under IRC §419A(b).
• All post-retirement benefits are done on a target basis and are funded through separate
accounts, thus fulfilling the requirement of IRC §419A(d). All post-retirement benefits
are paid from those separate accounts.
• Frequently, clients elect to invest such funds in tax-sheltered investments, including life
insurance policies and tax-exempt mutual funds.
• Medical benefits are limited to IRC §213(d) expenses.
• Contributions for such arrangements are tax-deductible, and benefit payments under such
an arrangement are tax-exempt.
• The Participant may use his account for the purchase of health insurance, long-term care
insurance, or reimbursement of out of pocket medical expenses. Such arrangements may
be considered a medical expense reimbursement plan described under IRC §105(h).
However, legitimate 419(e) Plans are hard to find. While a legitimate plan might be considered
aggressive planning for the right business owner, every plan the author has seen – with the
notable exception of at least one plan – can be characterized as abusive. For this reason, the IRS
has been concerned about the rampant abuse from some – although not all – forms of 419(e)
Plans. Therefore, employers who wish to use these aggressive arrangements need to be cautious
and well counseled, lest they cross the line from aggressive to abusive.
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