QUESTION: Our company recently established an ERISA self-insured major medical plan for employees. One of the concepts we have heard about but do not fully understand is a VEBA. What is a VEBA, and should we have one for our self-insured medical plan?
ANSWER: VEBA stands for voluntary employees’ beneficiary association, a special tax-exempt entity recognized under Code § 501(c)(9). It is essentially a trust established to pay certain benefits—including health benefits—to VEBA “members” (generally, current or former employees) or their dependents or beneficiaries. While a VEBA can be used as a funding mechanism for a self-insured health plan, establishing a VEBA is not necessary and might not provide any practical advantages in connection with your company’s medical plan.
If plan benefits are paid from the company’s general assets (or a combination of general assets and participant contributions made through a cafeteria plan), your company generally is not required to establish a trust. But if your company establishes a VEBA to fund plan benefits, then the VEBA’s assets will be ERISA plan assets and will be subject to ERISA’s trust requirement and plan asset rules. Code § 501(c)(9) also imposes requirements on a VEBA’s ongoing operation. These requirements include nondiscriminatory coverage and benefits; prohibition on the “inurement” of VEBA assets to any individual other than through permitted benefits (for example, payment of disproportionate benefits or unreasonable compensation for services); recordkeeping and annual reporting requirements; and, as discussed below, an excise tax on reversions. In addition, an application for recognition as a tax-exempt entity must be submitted to the IRS (using IRS Form 1024) within 15 months after the end of the month in which the VEBA was organized.
Given these administrative burdens, why establish a VEBA for a self-insured health plan? The principal benefit of a VEBA over other funding methods is that a VEBA is a tax-exempt entity, so the plan’s investment income generally accumulates tax-free. (VEBAs are, however, subject to tax on any “unrelated business taxable income.”) This may be advantageous if the VEBA will hold and accumulate assets over a period of time and rely on investment returns to help fund benefit obligations. For example, a VEBA might be used to fund a retiree medical plan, where accounting rules or other considerations support advance funding of a trust. On the other hand, there might be little or no practical advantage if the VEBA will maintain a low (or zero) balance—for example, if your company intends to pay claims monthly as they are received.
Finally, as a trade-off for tax-exempt status, the Code imposes a 100% excise tax on any VEBA assets reverting to the employer. This excise tax effectively prevents the employer from recovering any assets that might remain after a VEBA is terminated and has paid all claims and administrative expenses. Of course, you should consult your company’s legal and tax advisors to determine what funding mechanisms may be appropriate for your company’s particular circumstances.
For more information, see EBIA’s Self-Insured Health Plans manual at Sections VI.G (“Federal Tax Treatment of Welfare Benefit Funds”), XVIII.C (“Funding Methods”), and XIX.B (“Voluntary Employees’ Beneficiary Association (VEBA)”).
Contributing Editors: EBIA Staff.
