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 health 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 generally not necessary and might not provide any practical advantages in connection with your company’s medical plan.
One consideration is ERISA’s requirement that plan assets be held in trust. If plan benefits are paid entirely from the company’s general assets, those amounts are not plan assets, and no trust is necessary. Nor is a trust necessary if the plan accepts participant contributions (which are plan assets), so long as those contributions are made through a cafeteria plan and certain other requirements are met. But if your company establishes a VEBA to fund plan benefits, the VEBA’s assets, including employer amounts that would not be plan assets if they remained part of the company’s general assets, will be subject to ERISA’s trust requirement (met by using the VEBA) and other plan asset rules. In addition, Code § 501(c)(9) 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. Also, 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—if the submission is not timely, complete, and accurate, the VEBA may be treated as tax-exempt only from and after the date all required information is filed.
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 funding of a trust in advance. 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.
Moreover, 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 all claims and administrative expenses have been paid. (Excise tax considerations may also arise when modifying a VEBA so that amounts may be used for different or additional purposes than originally contemplated.) Of course, you should consult your company’s legal and tax advisors to determine what funding mechanisms may be appropriate for your company’s 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)”), and the sample “Health and Welfare Benefits Trust Agreement” (available in the manual’s Appendix). See also EBIA’s ERISA Compliance manual at Sections XIV.D (“Plan Asset Category #2: Employer General Assets Can Become Plan Assets”) and XVI.B.2 (“Trust Nonenforcement Policy for Participant Contributions Under Cafeteria Plans”).
Contributing Editors: EBIA Staff.