Retiree Medical Accounts

Why is healthcare coverage important for retirees? After all, they're covered by Medicare, right? Perhaps, but Medicare doesn't provide 100 percent healthcare insurance coverage. Much as Social Security benefits provide for minimum retirement income, Medicare is primarily meant to keep seniors out of poverty by covering much of their healthcare needs.

The average retired couple pays thousands of dollars for Medicare supplement premiums, deductibles, co-payments, and other costs. In 2010, Medicare covered 62 percent of the cost of healthcare services for Medicare beneficiaries age 65 and older, while out-of-pocket spending accounted for 12 percent, and private insurance covered 13 percent (Medicaid, Tricare, VA benefits, and other sources comprised the remaining 13 percent).

According to the Employee Benefits Research Institute, a couple retiring in 2014 who take prescription drugs and want to ensure they have at least a 90 percent chance of having enough money to treat their aging bodies would need an extra $326,000 in savings earmarked specifically for healthcare.

The good news for employers is that good healthcare coverage tends to breed good health and even better healthcare coverage. For example, Medicare recipients who report their health as excellent or very good are more likely than those in poor health to have employer-sponsored coverage (34 percent versus 18 percent), more likely to purchase Medigap coverage (24 percent versus 16 percent), and more likely to be covered under private Medicare Advantage plans (25 percent versus 18 percent). Since they tend to be in good health when enrolling in Medicare, employer-sponsored coverage throughout a worker's career appears to be a good investment in curbing healthcare expenses when they retire.

Unfortunately, employer-sponsored retiree healthcare benefits suffer the same challenges facing pension plans: Today's retirees are living longer and it therefore costs significantly more to provide them lifetime coverage. To complicate matters further, a Supreme Court ruling issued this year will likely change the way union retirees and their employers offer retiree healthcare benefits.

In January of 2015, the Supreme Court handed down a unanimous decision in M&G Polymers v. Tackett, eradicating the presumption that collective-bargained benefits are meant to last a lifetime. Known as the "Yard-Man" inference, the court's ruling sets the precedence that while retiree healthcare benefits may vest once a worker retires, they are not presumed to continue until the worker passes away unless there is language specifically stating this in the plan documents.

The impact of this ruling is dual-fold. First, since agreements that were drawn up in the 1960s and 1970s generally do not include duration guidelines for retiree healthcare benefits, many retirees today could see their benefits reduced or eliminated. One expert estimated that anywhere from 40 to 50 percent of collective-bargaining agreements in effect today do not stipulate lifetime vested healthcare benefits.

Second, for current agreements and those drawn up in the future, the question of lifetime healthcare benefits offers a new point of contention. Employers must review their plan documents to determine if there is presently language conferring lifetime benefits; any changes they wish to make regarding retiree healthcare benefits will have to be bargained with the union.

Retiree Medical Benefits Trust
There are several types of vehicles used to implement collective-bargained agreements for retiree healthcare benefits. One such plan is a Retiree Medical Trust, which is a fund established by a union and its participating employers to provide supplemental retiree health benefits through reimbursement of medical costs. Typically, this type of arrangement serves as a multi-employer, non-profit trust governed by an equal number of union and employer trustees. The trust's reimbursement program is generally managed by hired professionals who oversee the services of a third-party administrator (TPA), an attorney, an actuary, and a financial investor.

The trust benefits from tax advantages as provided under the IRS tax code § 501c(9). Because of its tax status, money contributed to the fund is not taxed; interest earned by the fund is not taxed; and healthcare reimbursement money is not considered taxable income.

Voluntary Employees Beneficiary Association
A Voluntary Employees Beneficiary Association, known as a "VEBA", is a mutual association funded by its member workers and/or their employer that provides specified benefits. Any group of workers sharing an employment-related common bond may establish a VEBA, or an employer may establish a VEBA on behalf of its workers. The VEBA was first established as part of the Revenue Act of 1928, and is manifested as a trust, corporation, or association to which employer and/or employee contributions are made.

An individual employer or a collective group of ten or more employers who each contribute less than 10 percent of the total funding have the option to establish a VEBA as either a tax-exempt or a taxable trust under IRC § 419A. The plan qualifies as tax exempt if it meets the requirements of Code Sections 501(c)(9) and 505, and may include health benefit plans, life insurance, disability insurance, accident insurance, vacation, or other employee benefits.

VEBA plan sponsors may deduct contributions to the plan in the same year in which they are made, and workers do not pay income taxes on amounts contributed on their behalf. Contributions for post-retirement medical expenses also may accrue interest and be drawn by retirees on a tax-free basis. Because Labor Department regulations encourage employers to fund this type of plan in a trust separate from the employer's assets, a retiree medical benefits trust can be established as a VEBA with a bank or financial institution serving as an independent trustee. However, a VEBA also may be organized as a corporation or association that is recognized under local law.

A VEBA must be a bona fide association with governing documents that is independent of both the employer and workers. Its membership is open to all workers under a collective bargaining agreement, union or local, as well as to workers of a particular employer or group of employers. IRC § 505 subsection imposes nondiscrimination requirements and requires that VEBAs apply for and receive a favorable ruling from the IRS. While a VEBA cannot discriminate in favor of a highly-compensated group, regulations do permit certain arrangements that generally favor a highly compensated group. For example, membership can be denied on the basis of a reasonable job classification, a minimum length of service, part-time employment, or union coverage.

VEBAs used to fund post-retirement medical coverage allow for a method of funding that removes the liability from the employer's balance sheet through a single premium insurance settlement. This buyout transfers the liability for a defined group of retirees to an insurance underwriter, and will retain the same tax treatment as the VEBA funding arrangement. This settlement is irrevocable and guarantees future payments to retired plan participants and beneficiaries. It is often used to segregate liabilities in mergers, acquisitions, and divestitures.

401(H) Plan
A 401(h) plan refers to the section of the Internal Revenue Code, which allows for an employer to establish a pension or annuity plan to provide for payment of benefits for sickness, accident, hospitalization, and medical expenses for retired employees, their spouses, and dependents. This type of plan must be established and maintained as a separate account from a pension plan.
Employer contributions are 100 percent tax deductible and retirees pay no income taxes on benefits drawn to pay for medical expenses. Therefore, funding a separate 401(h) account in addition to a pension provides a valuable benefit, since income drawn from a pension plan is taxable. The 401(h) account pays for a retiree's medical expenses so that he does not have to use money from his taxable pension plan.

Many employers utilize both a VEBA and section 401(h) account for retiree healthcare benefits, as they may fund and deduct a greater amount of contributions than either arrangement provides separately.

Health Savings Account
An employer can set up a Health Savings Account (HSA) for workers who opt for coverage under a high deductible healthcare plan (HDHP). Both workers and employers may contribute to the plan, subject to annual limits; contributions are sheltered from income taxes, the money grows tax-deferred, and the funds can be withdrawn tax-free for medical expenses (or for any reason after age 65). Upon retirement, retirees may continue to contribute to the HSA until they enroll for Medicare. At that point, they can no longer contribute to the account, but may continue to tap the account to pay for:

• Medicare premiums, deductibles, co-payments, and co-insurance
• Medicare parts A, B and D (prescription-drug coverage)
• Medicare Advantage
• Long-term care insurance premiums
• Worker's share of health insurance premiums for employer-based coverage (age 65+)
• Premiums for COBRA continuation health insurance coverage from a former employer
• Healthcare coverage subject to the age limits in the Internal Revenue Code
• Medical services provided in other countries

Note that HSA funds may not be used to pay for Medigap insurance premiums.

Medicare Benefits
Regardless of which type of retiree healthcare plan is deployed, retiree insurance is always secondary to Medicare. Therefore in most cases, retirees should enroll in Medicare Part A and Part B once they become eligible. While employer-sponsored coverage may differ depending on the specific rules of each plan, generally medical expenses are first reimbursed by Medicare before another retirement healthcare accounts kicks in. In fact, some plans may not cover medical costs during any period in which a person is eligible for Medicare but not enrolled.

However, if a retiree has other health insurance that offers creditable drug coverage that is at least as good as Medicare's basic Part D prescription drug plan, he needn't enroll in Part D when he becomes eligible for Medicare. Should the retired worker subsequently lose his creditable drug coverage, he may enroll in Part D during a Special Enrollment Period that begins on the first day he loses drug coverage and ends 63 days later.

It's important that each retiring worker retain a copy of his plan's benefit booklet provided by his employer or union to learn how his retiree coverage works with Medicare. Workers also should be aware that employers are not required to provide retiree coverage and they may change benefit and premium amounts, or even cancel coverage.

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