QUESTION: Our company sponsors a health reimbursement arrangement (HRA) that is integrated with our major medical plan and reimburses qualifying medical expenses incurred by eligible employees and their spouses, tax dependents, and children who have not attained age 27 by the end of the taxable year. One of our employees just died, leaving a substantial unused HRA balance. Can we pay the unused HRA balance to the employee’s surviving spouse?
ANSWER: No. HRAs may only reimburse medical care expenses as defined in Code § 213(d). A cash payment after an employee’s death or at any other time would disqualify your company’s HRA for all participants and make all reimbursements paid from the HRA taxable—even reimbursements for qualifying medical expenses. Not only is the HRA itself prohibited from paying cash-outs, so is any arrangement outside of the HRA. For example, if your company paid the surviving spouse a cash death benefit under a separate program outside of the HRA, and the benefit was related in any way to the deceased employee’s remaining unused HRA balance, that death benefit would disqualify the HRA for all participants and would result in the taxation of all reimbursements from the HRA.
While HRAs cannot be cashed out, they can permit a post-death “spend-down” under which the balance remaining after an employee’s death is available to pay for qualifying medical expenses of the employee’s surviving spouse, tax dependents, and qualifying children. You should review your HRA plan document to determine whether it has a post-death spend-down feature; if so, the deceased employee’s unused HRA balance could be spent down according to the terms of your plan. The plan document could also be amended (in accordance with its amendment procedures) to add such a feature. Note that any such amendment would have to comply with the Code’s nondiscrimination rules, which prohibit discrimination in favor of highly compensated individuals. These rules generally require, among other things, that all benefits provided to highly compensated participants be provided to all other participants. Note also that IRS Notice 2015-87 (see our Checkpoint article) has made it uncertain whether a post-death spend-down feature can be used by family members who do not also have major medical coverage. Absent further IRS clarification, the cautious approach would be to restrict post-death reimbursements to family members with such coverage. However, HRAs that do not require family members to have major medical coverage but are otherwise integrated based on their plan terms as of December 15, 2015, do not need to impose that restriction for plan years beginning before 2017.
When administering a post-death spend-down feature, be careful to reimburse only eligible individuals’ qualifying medical expenses. If other individuals’ expenses are reimbursed, then all reimbursements from the HRA will be taxable, including reimbursements for qualifying medical expenses of other eligible employees, their spouses, tax dependents, and qualifying children. And keep in mind that if your company is subject to COBRA, then qualified beneficiaries who lose their HRA coverage due to a COBRA qualifying event (such as the covered employee’s death) must be offered the opportunity to continue their HRA coverage for the COBRA-prescribed time period, whether or not your company’s HRA includes a post-death spend-down feature.
For more information, see EBIA’s Consumer-Driven Health Care manual at Sections XXI.B.2.e (“No Cash-Out of Unused Amounts (but Spend-Down Is Possible”), XXII.B (“Who Can Be Provided Tax-Free Benefits?”), XXII.C.2 (“Treatment of HRAs Upon a Participant’s Death”), XXIII (“HRAs: Nondiscrimination”), and XXV.B (“HRAs and COBRA”).
Contributing Editors: EBIA Staff.