Growing businesses always are looking for ways to attract and retain valuable employees. Providing a wide range of benefits from executive compensation and retirement to life insurance and health care is one of the ways employers can accomplish this. Companies are finding that 419(e) single-employer welfare benefit plans or 412(i) defined benefit plans can help fill the void in their employee benefit program.
419(e) Plan Basics
Single-employee welfare benefit plans can add to a company’s benefit program by providing a pre-retirement death benefit and/or a post-retirement medical reimbursement on a tax-advantaged basis. Employees receive a valuable employer-provided benefit while the employer receives a current tax deduction.
A 419(e) single-employer welfare benefit plan is not a qualified plan, so there are no premature withdrawal penalties, minimum distributions or maximum contribution or compensation limits. However, 419(e) plans are subject to the Employee Retirement Income Security Act (ERISA) of 1974 and are thus subject to all the appropriate regulations and requirements.
Family-owned entities may find these plans attractive because they can replace benefits that would otherwise be paid with after-tax dollars. Since family businesses often have relatively few non-family employees, the cost for benefits to non-family employees may be relatively small.
Because 419(e) plans provide employee benefits other than deferred compensation and retirement benefits, they must not be structured as a deferred compensation or retirement plan. Specific benefits covered by the plan can include disability, medical, supplemental unemployment severance and life insurance benefits.
Below is an overview of one application that may be of great interest to family-owned entities.
419(e) Post-Retirement Medical Reimbursement Plan
Business owners can address employees’ concerns over the rising cost of post-retirement health care costs by contributing to a 419(e) post-retirement medical reimbursement plan (PRMRP). Tax-deductible contributions allow employers to use pre-tax dollars to fund a reserve account for post-retirement and long-term health care benefits.
Reimbursements can be made for almost all out-of-pocket health expenses and even long term care insurance premiums. Reimbursements can be made to either plan participants, their spouses and, under income tax rules, their dependents.
The benefit must be offered to all full-time employees meeting a nondiscriminatory minimum age and service requirement. The benefit is popular with family businesses because the plan may be designed so that no one vests until they reach retirement and participation ends at termination of employment. This benefits remaining employees–usually the owner’s family.
Income Tax Treatment of Employees
Employer contributions to a 419(e) PRMRP are not taxable to the employee. After retirement, the distributions are not viewed as income as they cover health care and long term care expenses. Both plan contributions and distributions are tax-free.
Funding the Trust
Contributions to a 419(e) PRMRP must be placed in a trust that may own a life insurance policy. Because 419(e) is not a qualified plan, the trust may have to pay income tax on trust earnings. However, if cash value life insurance is purchased, amounts that would otherwise be taxed to the trust accumulate tax-deferred inside the policy.
IRC Section 419 limits deductions to the “qualified cost” for any taxable year. The qualified cost is reduced by the after-tax income of the fund, which also reduces the employer’s tax deduction. Tax-deferred vehicles such as life insurance do not decrease the tax deduction and are attractive funding mechanisms.
When life insurance is used as a funding vehicle, the 419(e) PRMRP trust must be the owner and beneficiary of the policy.
412(i) Plan Basics