The past few years have seen double digit increases in health care costs. Employees are being
asked to pay an increasing portion of these expenses through increased premiums and co-
pays. These escalating costs pose a special problem for retired employees on a fixed income.
There are a variety of plans that permit employees to accumulate assets on a tax deferred basis
to provide retirement income, such as 457, 403(b), 401(a) and IRAs.
However, there is only one plan that provides a similar opportunity to provide income for health
expenses – the Voluntary Employee Benefits Association or “VEBA.” In addition to accumulating
assets on a tax favored basis for retirees a VEBA can provide current employees and employers
with an effective plan that works in conjunction with a Section 125 plan, for meeting current
expenses.
VEBAS
A VEBA is a separate legal entity established as an exempt trust under Federal law, specifically
Section 501 of the Internal Revenue Code. This is the same section that allows for the
establishment of retirement programs such as CALPERS and STRS as well as other types of
qualified retirement plans. VEBA’s have been part of the tax law for decades and are widely
utilized by many private sector companies, labor unions and public agencies to provide health
and other welfare benefits.
A VEBA is similar to a retirement plan in many important respects. Contributions may be made
pre-tax, earnings accumulate tax - free and the assets are held in a separate trust safe from
creditors of the employer. An important difference is that distributions from a VEBA may be used
to provide health care and other types of welfare benefits to current and retired employees on a
pre-tax basis. Distributions may also be used to pay other types of health and welfare benefits.
VEBA Benefits
A VEBA may provide for many different types of benefits. In addition to health care
reimbursement, it may pay for benefits that are taxable to employees such as subsidized
housing. Other eligible expenses include child care, tuition and transportation assistance. Other
major components of any benefits program such as life and disability benefits may also be
included. A VEBA Trust is capable of “wrapping around” all types of benefits and providing an
employer with a single entity for paying and administrating various benefits. It is a particularly
flexible vehicle because funds not used by an employee for one benefit may be used later for a
different benefit. A wide range of medical benefits of the employee or retiree and their
dependents can be reimbursed tax free. A VEBA offers a particularly flexible, tax effective
vehicle to accumulate assets to pay for the health and related medical expenses of its members
and their dependents. Health related expenses include a wide range of expenditures such as
premiums and deductibles. An important aspect of the flexibility of the VEBA is that it may
provide these benefits to employees and their dependents either while they are employed or
after they retire. A full list of medical benefits that qualify for reimbursement is contained at end
of this article.
VEBA / Section 125 Plan
Contributions may be made to a VEBA to pay the expenses of current employees. For instance,
using the VEBA in this manner for health expenses may offer some advantages as compared to
a section 125 plan. These advantages include different rules on forfeitures and possible
administrative simplification. It may be also be advantageous to use the plans in tandem.
Retired Employees
Contributions made for current employees may be accumulated for post retirement health care
costs, a rapidly growing component of overall retirement expenses for employees. There are a
number of vehicles for employees to accumulate assets for retirement income pre-tax. However,
a VEBA is the only feasible vehicle to accumulate funds on a tax free basis for post retirement
health costs.
A VEBA is a highly tax effective way to accumulate assets to pay post retirement health
expenses. There is a three-fold tax advantage. Employer contributions are not taxable to the
employee when made to the trust, they grow tax free, and they are not taxable when used to pay
or reimburse an employee for a qualifying expense. This permits major tax savings.
Pre-Tax Payment
For example, a retiree with a VEBA account at retirement of $10,000 could enjoy the following
savings:
If the amount were paid from a pension plan:
Gross Amount $10,000
Less Taxes 3,500 ($10,000 X 35%) (Assumes a combined federal and
state tax rate of 35%)
Net Amount available to pay health premiums would be $6,500.
Health expenses are generally not deductible since they must exceed a threshold of 7.5% of
adjusted income before they become deductible. To retirees this means they must first receive
their pension payments and pay tax on the entire amount before they pay medical premiums and
expenses.
If the amount is paid from a VEBA:
Gross Amount $10,000
Less Taxes - 0 –
Net amount available to pay health care premiums is $10,000
The VEBA saved $3,500 in taxes.
INDIVIDUAL ACCOUNTS
Employer contributions may be allocated to individual accounts set up for each member of the
plan. Membership in the plan and the level of contributions is determined by the provisions of
the agency’s program. A major advantage of the VEBA in this respect is that it is highly flexible.
Different employers may use it to fund different benefits e.g., pre-retirement medical benefits or
post retirement benefits, day care, etc.
A further example of flexibility is an arrangement in which a designated amount is made available
to an employee and he/she decides which benefits to spend it on.
After the contributions are made, employees will then be permitted to make claims for medical
reimbursement or other benefits and benefits will be paid. These amounts will be charged
against the value of their accounts. These claims will be processed, and all of the other
administrative tasks will be accomplished by an administrative company retained on behalf of the
plan.
Terminating Employment
If an employee leaves employment before retirement or moves out of state he maintains his
status as a member of the VEBA and is eligible to draw benefits until his account is exhausted.
Employee's Death
If the employee is survived by a spouse, or other dependents as defined by the IRS, they
continue to be eligible to receive medical expenses reimbursement payments until the account is
used up. If there are no eligible dependents the funds will be paid as medical expenses
reimbursement to the heirs of the estate. If there are no heirs the balance in the account will be
used to pay the plan’s administrative expenses or reallocated to the accounts of the other
members.
ACCRUED VACATION / SICK LEAVE
If legal requirements are met, sick leave, vested vacation pay and other types of accrued
compensatory time may be converted into their cash equivalent. This amount is deposited by the
employer into the trust on behalf of its employees and used to purchase tax exempt health or
other benefits, in lieu of taxable cash. Based on very recent Internal Revenue Service releases
involving Public School Districts, this may be an extremely important use for a VEBA. Pay of this
nature may be taxed by the IRS when vested, based on the IRS opinion, which would mean
taxation currently, instead of at termination or retirement.
This Memorandum is meant only as a brief synopsis of a VEBA and its possibilities for Public
Sector Employers
For Further Explanation--
If you wish to speak directly with our firm, we will maintain all confidences requested. Call Ralph
Amadio or Myles Margady, Esq. at 888-466-4599
You may e-mail us at: info@publicagencyretirement.com
WHAT HEALTH BENEFITS MAY BE PAID FROM THE VEBA?
Eligible expenses encompass a wide range of expenditure, including:
Medical Insurance
Dental Insurance
Vision Insurance
Health Maintenance Organizations (HMO’s)
Long Term Care (Tax Qualified)
Medicare Part B
Medicare supplement
Insurance plan deductibles and co-pays
Prescription co-pays
Expenses currently reimbursed through Flex plans
Qualified expenses are outlined in Internal Revenue Code Section 213 and IRS
Publication 502 (available by calling 1-800-TAX FORM or from the IRS Website at http:
//www.irs.gov)
