Healthcare Providers

Section 457(f) Regulations -- Getting Closer to Publication?

After nearly a year's silence, Cheryl Press, an IRS Senior Attorney working on the regulations, addressed the regulations on March 10, 2011. Speaking at a conference, she did not address when the regulations might be issued, but instead described a couple of provisions that had not previously been discussed. In addition to addressing substantial risks of forfeiture (presumably moving to the Section 409A non-elective, cliff vesting only model), Ms. Press said that the regulations will also cover illness and vacation leave, and what they require to be deemed "bona fide" arrangements that are exempt from the substantial risk of forfeiture requirement. Regarding the illness and vacation leave, she expressed concern that these arrangements are being used to increase 403(b) deferrals (presumably the ability to convert illness and vacation leave accruals to 403(b) contributions at the time of termination), or to be a type of "savings account" where the participant can take funds out and put them back in.

The last word we had from Ms. Press regarding the timing of the regulations was in April 2010, when she said the regulations were "substantially done." The new comments may signal they are not so far away from being published. But then again ...

IRS announcement on impact of Health Reform Act

As anticipated, yesterday the IRS announced that compliance with the new rules will not be required until the IRS is able to issue guidance/regulations with more details about what the rules mean and how to comply. Like most of the health reform act, in the absence of good legislative history and clear statutory language, the regulators are having to make things up as they go. The IRS has allowed for a comment period that extends to March 11, 2011.  That means that the new regulations likely will not be out until summer at the earliest.  Even then, they may have a deferred effective date.

Regarding the substance of the new rules, many questions remain to be answered as to how they apply to post-termination continuation of health benefits.  The biggest question is whether the rules even apply at all to post-termination continuation.

Group Health Plan Discrimination Rules

In our post of 10/29, we outline the new discrimination penalties imposed on discriminatory group health plans.  These rules impact PRM plans for select employees.  Grandfathering is important and is generally for plans in effect prior to March 23, 2010.  Unlike other grandfathering provisions, the regulations list a series of actions that will cause the grandfathering to be forfeited.  The first of those was changing carriers.  However, the regulations have been amended to eliminate that condition.  Therefore, employers can change carriers and not lose grandfathering so long as the terms of the coverage do not change in a prohibited way (see earlier notes).  This change was made given the number of carriers that are ceasing to provide current plans.

HRA impact on post-retirement medical plans

The new healthcare legislation imposes penalties on employers that have group health plans that discriminate in favor of the highly compensated (e.g., any of the 25% most highly-compensated employees) in eligibility for benefits or in the amount of benefits.  The penalty is $100 per day for each employee discriminated against, up to $500,000 per year.  The legislation and first set of regulations leave many questions unanswered.  As we continue our research, we have determined as follows:

  1. Grandfathering.  Plans in effect prior to March 23, 2010 are grandfathered.  Grandfathered plans can adjust for increasing premiums without losing grandfathering, but other provisions should not be changed without careful review.  In the case of a PRM provision contained in an employment agreement, the agreement could be updated, but the wording of the PRM provision should expressly not be changed.
  2. Single Participant Plans.  Group health plan does not include any arrangement “that has fewer than two participants who are current employees.”  This language would exempt an arrangement only for a single current employee, such as the CEO.  The language may also exempt arrangements for a broader group if “participation” means actually receiving coverage, versus being under the promise of receiving such coverage in the future.  Future clarification will be needed to determine if PRM for more than a single executive is exempted under this provision.
  3. Group Health Plan.  PRM may also be excluded from the basic concept of a group health plan.  The participant is often tasked with finding his or her own coverage, and the employer’s only involvement is to pay the premium to the carrier or to reimburse the participant’s premium payments.  There is no group underwriting in such cases.  These distinctions may be a basis for excluding PRM for broader groups, but additional guidance is required to confirm that result.
  4. Long-Term Care.  LTC is not subject to these new rules so long as the LTC is provided under a separate contract from the employer’s group health plan and there is no coordination of benefits between the two.  This is a significant relief as LTC is treated as health coverage for tax purposes generally.  The healthcare regulations contain a specific exemption for LTC provided under a separate contract.  Therefore, employers can continue to offer LTC to a select group of employees.

IRS announces pension plan limits

The Internal Revenue Service today announced cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2011. In general, these limits will either remain unchanged, or the inflation adjustments for 2011 will be small. Highlights include:

  • The elective deferral (contribution) limit for employees who participate in section 401(k), 403(b), or 457(b) plans, and the federal government's Thrift Savings Plan remains unchanged at $16,500.
  • The catch-up contribution limit under those plans for those aged 50 and over remains unchanged at $5,500.
  • The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are active participants in an employer-sponsored retirement plan and have modified adjusted gross incomes (AGI) between $56,000 and $66,000, unchanged from 2010. For married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan, the income phase-out range is $90,000 to $110,000, up from $89,000 to $109,000. For an IRA contributor who is not an active participant in an employer-sponsored retirement plan and is married to someone who is an active participant, the deduction is phased out if the couple's income is between $169,000 and $179,000, up from $167,000 and $177,000.
  • The AGI phase-out range for taxpayers making contributions to a Roth IRA is $169,000 to 179,000 for married couples filing jointly, up from $167,000 to $177,000 in 2010. For singles and heads of household, the income phase-out range is $107,000 to $122,000, up from $105,000 to $120,000. For a married individual filing a separate return who is an active participant in an employer-sponsored retirement plan, the phase-out range remains $0 to $10,000.
  • The AGI limit for the saver's credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $56,500 for married couples filing jointly, up from $55,500 in 2010; $42,375 for heads of household, up from $41,625; and $28,250 for married individuals filing separately and for singles, up from $27,750.


Plan Adjustment/Termination Options

As employers consider changes to their key employee benefit packages, many ask whether they can change their current nonqualified deferral plans, and if not, whether they can terminate their plans and start over.  Options are available, but careful attention must be paid to 409A to avoid penalties.  The general principles are:

  • For prior accruals, payment of benefits cannot be accelerated.  Payment can be postponed if the change is made at least 12 months in advance, and if the payment is postponed at least five years.
  • For future accruals, changes must be made by December 31 preceding the first day of the plan year in which the changes are to take effect.
  • Benefit accruals can be frozen at the end of any year, and then held until payable under the normal terms of the plan.
  • Plans can be terminated and benefits distributed early if:
    • All plans in the same category (e.g., account balance) are terminated
    • No benefits are paid for 12 months
    • All benefits are paid in months 13 to 24 after the termination
    • The employer does not adopt a plan in the same category for at least three years after the termination (the employer can adopt a plan in a different category or an exempt plan (e.g., short-term deferral plan))
  • Interests of individual participants in a plan can be terminated and distributed early if the participant’s total benefits from all plans in the same category are paid out, and if the total amount distributed is less than the annual deferral limit (i.e., $16,500 in 2010).

457(f) Regulations Languish

On August 6, 2010, it will be three years since the IRS announced its intent to publish new regulations under Section 457(f).  We continue to wait.  In May, an IRS attorney said the regulations are “substantially done,” but that they are proceeding at a “governmental pace.”  That may indicate we still have a while before they see the light of day. Once published, the regulations are expected to:

  • Disallow noncompete restrictions
  • Limit voluntary deferrals (including rolling vesting dates)
  • Treat some severance payments as deferred compensation (requiring lump sum taxation at termination of employment)

Once the new regulations are issued, we will learn how and when deferral and severance plans must be modified to comply with the new requirements.  In the meantime, many organizations have retained their plans with noncompete restrictions and one-time opportunities to postpone the vesting date.  These plans will be positioned to take advantage of any favorable transition rules that may be offered.

There is also a steady stream of clients who, frustrated by the delay and uncertainty with the regulations, act ahead of the regulations and switch to cliff vesting for new deferrals. Each employer must choose its preference – the attractiveness of noncompete restrictions versus the certainty of cliff vesting.