Are VEBAs a Viable Alternative Benefit Plan?

As the cost of providing employee health and life insurance benefits continues to skyrocket, many manufacturers are looking for alternatives to standard insurance coverage. Depending on your company’s circumstances, a Voluntary Employees Beneficiary Association (VEBA) may be one alternative worth considering.

Pooled participation

VEBAs aren’t retirement plans; they’re welfare benefit plans typically set up as trusts with banks serving as trustees. Unlike other benefit plans, VEBAs don’t include separate accounts for each company. Instead, VEBA assets are pooled in a trust. The trust buys insurance coverage for each participant with the accumulated funds based on each employer’s participation level.

While you may designate any salary multiple for each employee, the multiple must be uniform for all of your employees. In addition, you may not contribute more than 10% of the total contributed by all the employers in the trust. Thus, the VEBA should have at least 10 member employers, each contributing roughly equal amounts.

Even though VEBAs are covered by nondiscrimination rules, they include optional exclusions for certain categories of employees. You may choose, for instance, not to include part-time workers, those with less than three years of service or union employees.

VEBA benefits

The advantages of using VEBAs can be significant. For example, employer contributions are deductible as ordinary and necessary business expenses, there are no age requirements or penalties on benefit distributions, and there are no limits on annual contributions — which grow tax-deferred and may not be subject to gift or estate taxes.

VEBAs are tax-exempt if they meet these requirements:

• Membership is voluntary.

• Members have a common, employment-related interest.

• Benefits aren’t provided to only one employee.

• The arrangement provides at least life, sickness, accident or other benefits to members or their beneficiaries.

You may be a member of your company’s VEBA as long as your employees represent at least 90% of the membership.

VEBAs are subject to some Employee Retirement Income Security Act (ERISA) rules, but they aren’t bound by the rules governing qualified plans or by strict pension plan rules. Thus, you may make more tax-deductible contributions to VEBAs than to 401(k) plans. You also may deduct larger contributions than would be permitted for qualified plans, making VEBAs an attractive option for companies whose qualified plans are overfunded.

VEBAs offer many benefits, including health and life insurance, salary continuation, long-term care insurance, and even college education and vacation benefits to participants and their beneficiaries. They may be used in conjunction with other plans, including retirement or traditional insurance plans.

Although VEBAs are available to any business, they’re particularly suited to profitable businesses that want to reduce tax liabilities or reduce retained earnings. They also are beneficial for businesses with fluctuating incomes.

If, for example, divesting a product line nets your company a sizable cash advantage and an equally sizable capital gain, large contributions to a VEBA can help offset the tax liability.

Reducing risk

Because the trust owns the assets, VEBAs may be beneficial for companies in high-risk businesses such as pharmaceuticals or software development. Even if such firms lose lawsuits or are forced into bankruptcy, VEBA assets are protected from creditors.

Additionally, you may terminate your company’s VEBA plan at any time as long as there’s a legitimate business reason to do so, such as if you’re selling the business or can no longer fund the plan. In that case, the value is distributed pro rata among current participants. Employees with higher percentages of income receive higher percentages of the plan assets. These benefits are taxable as income in the year they’re received.

Is a VEBA right for your company?

Even though VEBAs operate relatively simply, they can be complicated to set up. Some trusts that may appear to be VEBAs aren’t, because they haven’t received the IRS determination letters required for program approval. Therefore, seek legal and financial advice before enrolling your manufacturing company in a VEBA.

Sidebar: Pension Protection Act goes beyond pensions

The Pension Protection Act of 2006 is designed to ensure full funding of employer-sponsored pension plans, but it also provides or extends tax benefits for other retirement plans.

Pension plans now must be fully funded by 2015, with a 10% tax penalty on companies that don’t make up funding deficiencies. To help soften the blow, however, the law allows employers to deduct the cost of any additional contributions they make to fund their pensions.

Additionally, employers now may automatically enroll employees in 401(k) retirement plans with default contribution levels. Employees who don’t want to participate must opt out of the plans.

Another key change is that nonspouse beneficiaries may roll over the assets they inherit from a qualified retirement plan into an IRA. This benefit was previously available only to surviving spouse beneficiaries.

Finally, the law eliminates several “sunset” provisions, including those on higher annual IRA contribution limits and catch-up contributions for people age 50 and older. It also makes permanent Roth 401(k) and Roth 403(b) plans, both of which were to have expired in 2010.

Back to M&D Newsletters & Articles 

Back to Tax and Business Update Summaries

To contact Feeley & Driscoll, please click here or call us at 1 (888) 875-9770.