Accounting, Funding and Tax Consequences

Determine the plan's short- and long-range financial needs and communicate the requirements to the appropriate person such as a trustee

The Conference Committee Joint Explanation states that a funding policy and method is a procedure to enable plan fiduciaries to determine the plan's short- and long-range financial needs and to communicate the requirements to the appropriate person, such as a trustee.

The assets in such accounts are subject to the claims of the employer's general creditors

In a general asset plan, the plan assets are not separate and remain commingled with the employer's assets. They appear as the employer's assets and are subject to the claims of the employer's general creditors, with usually no significant amount of such assets.

Avoiding filing for tax-exempt status, the annual tax-exempt trust return, and the plan modified annual return

A general asset plan offers administrative advantages including avoidance of filing for tax-exempt status (Form 1024), the annual tax-exempt trust return (Form 990), and the plan modified annual return. It also avoids the need for employer-provided bonds and the restrictions from 501(c)(9) trust regulations.

At least 10% of the plan's assets, with a minimum of $1,000 and a maximum of $500,000 per plan

Under ERISA, the fidelity bond must cover at least 10% of the plan's assets, with a minimum of $1,000 and a maximum of $500,000 per plan (or $1,000,000 for plans that hold employer securities). This protects against losses due to fraud or dishonesty by plan officials.

The contributions are used to pay the plan's fixed costs or claims within a brief period, generally about 10 working days but never more than 90 days

The 1989 final DOL regulations provided that participant contributions are plan assets that must be held in a trust. However, they could be held by the employer commingled with general assets for a brief period while being applied to insurance premiums or plan claims. The brief period was about 10 days (or two weeks) but never more than 90 days.

The creator, the trust agreement, the trust property, the trustee, and the beneficiary

The course identifies the five elements of a trust as (1) the creator, (2) the trust agreement that expresses the intent to create and maintain the trust, (3) the trust property, (4) the trustee, and (5) the beneficiary.

Medical contributions must not exceed 25% of total plan contributions, excluding past service pension contributions, as measured over the entire period during which such benefits were provided

To meet the subordinate test under the 501(a) pension trust, the medical contribution must not exceed 25% of the total plan contributions, excluding any past service pension contribution, as measured over the entire period during which such benefits were provided.

Coal mine operators, and an insurance company may not create or contribute to such a trust

Black lung trusts may be created by coal mine operators to facilitate and ensure long-term financing of liabilities for disability or death claims caused by black lung disease. An insurance company may not create or contribute to such a trust, and the trust must be irrevocable with no right of reversion.

Satisfying liabilities under the Coal Mine Health and Safety Act, purchasing insurance for such liabilities, paying incidental and administrative costs, investing in approved securities, or paying into the Black Lung Disability Trust Fund or U.S. Treasury

The purpose of a black lung trust is strictly limited. Trust assets may only be used to (1) satisfy liabilities under the Coal Mine Health and Safety Act of 1969, (2) purchase insurance covering such liabilities, (3) pay incidental and administrative costs, (4) invest in certain approved securities, or (5) make payments to the Black Lung Disability Trust Fund or the U.S. Treasury.

The qualified trust is a tax-exempt entity while the nonqualified trust is a taxable entity with earnings typically taxed at corporate rates

The nonqualified trust is a taxable entity, with earnings usually taxed at corporate rates, while the qualified trust is tax-exempt. The qualified trust files IRS Form 990, whereas the nonqualified trust files IRS Form 1041. Contributions to both types are generally deductible if actuarially supportable.

Because the disadvantages outweigh the advantages, primarily due to the trust earnings being taxable

The course notes that because the disadvantages outweigh the advantages, nonqualified trusts are rarely seen in practice. The primary disadvantage is that trust earnings are taxable, whereas a qualified 501(c)(9) trust has tax-exempt investment income. However, nonqualified trusts have fewer restrictions and are less costly and safer to administer.

To limit deductions for welfare plans to paid benefits with reasonable allowance for reserves, seeking consistency between all welfare plans and limiting revenue loss

DEFRA brought the funded welfare benefit plan concept that deals with timing of deductions, seeking consistency between all welfare plans. To limit revenue loss, Congress wanted to limit deductions for welfare plans to paid benefits with reasonable allowance for reserves. Congress also stopped overfunding abuses alleged with 501(c)(9) trusts.

An independent accountant's audit, bonding expenses, and the complexity of tracking and reporting plan assets

By not creating plan assets, the employer avoids an independent accountant's audit, bonding expenses, additional work tracking and reporting such assets, and the general added complexity of plan management.

The account must remain accessible to the employer's general creditors and aligns with the rules of a general asset plan

A non-trusteed, specially designated checking account is not considered a plan asset as long as it aligns with the rules of a general asset plan and the funds remain accessible to the employer's general creditors. These funds also cannot be claimed as tax deductions if treated as part of the employer's general assets.

The stop-loss agreement becomes a plan asset, subjecting the entire plan to independent accountant audit (for plans over 100) and employer-provided bonding

Where participant contributions pay any portion of the stop-loss premium, the stop-loss agreement becomes a plan asset. This subjects the entire plan to independent accountant audit (for plans over 100 in size) and employer-provided bonding requirements.

Because combining stop-loss premiums and administrative fees recognizes that the plan supervisor can provide both services and helps improve comparison between self-funded and fully insured plans

Combining stop-loss and administrative fees recognizes the reality that the plan supervisor can provide both services. This method also helps improve comparison between self-funded and fully insured plans by presenting costs in a comparable format.

The fully insured plan guarantees both the risk and the services, while the plan supervisor can only guarantee services and the stop-loss carrier can only guarantee the risk

One important distinction noted in the course is that the fully insured plan guarantees both the risk and the services, whereas in a self-funded arrangement the plan supervisor can guarantee only the services and the stop-loss carrier is capable of guaranteeing only the risk.

Claims must be paid within 90 days under ERISA's claims payment rules, serving as an outer limit for processing

ERISA has a 90-day claim payment provision. Additionally, stop-loss agreements usually require a claim to be paid within 30 days of approval for it to be reimbursable, and plan documents usually contain language that claims will be funded within 30 to 45 days of processing.

Once the employer funds a claim the obligation is forever expunged, trust losses fall on the trustees (the TPA), and uncashed checks eventually escheat to the state

The special trust language must set forth two caveats: (1) when the employer funds a claim, the obligation is forever, completely, and irrevocably met, and (2) trust losses are the obligations of the trustees (e.g., the TPA), while trust gains (uncashed checks) will escheat to the state. This protects the employer while avoiding plan asset creation.

The interest should be allocated to the employers because retaining it constitutes a prohibited transaction by a fiduciary dealing with plan assets for their own account

DOL Advisory Opinion 93-24A says the interest should be allocated to employers. When the TPA retains interest on the float, it is engaged in a prohibited transaction for its own account under ERISA Section 406(b)(1), which states that a fiduciary shall not deal with plan assets for their own interest or account.

The funded welfare plan rules place limitations on what may be claimed as a tax deduction on advance funding amounts, including the 35% safe harbor and related rules

Advance funding has decreased substantially since DEFRA and the funded welfare plan rules, which place limitations on what may be claimed as a tax deduction on advance funding amounts, including the 35% safe harbor and related rules. The IRC does not permit sufficient advance funding with deductions to be significant.

Because the corridor builds reserves legally owned by the employer, not the participants, even though employers often view these reserves as exclusively for plan use

Many argue that basing participant contribution levels on worst-case costs including the 20%-25% aggregate funding corridor is unfair because the corridor builds reserves legally owned by the employer, though employers often view these reserves as exclusively for plan use and benefits.

Unobservable inputs based on the entity's own assumptions

ASC 820 retains the three-level fair value hierarchy from FAS 157: Level 1 uses quoted prices in active markets for identical assets; Level 2 uses observable inputs other than quoted prices such as interest rates and yield curves; and Level 3 uses unobservable inputs based on the entity's own assumptions.

Observable market data (Level 1 and Level 2 inputs) over unobservable inputs (Level 3) when measuring fair value

Self-insured plans must use appropriate valuation techniques and inputs, prioritizing observable market data (Level 1 and Level 2 inputs) over unobservable inputs (Level 3) when measuring fair value under ASC 820. This ensures transparency and comparability across reporting entities.

The broker is totally insulated from the stop-loss transaction, and the concept of broker knowledge becoming insurer's knowledge is not applicable

When paid through the plan supervisor, the broker is totally insulated from the stop-loss transaction. The concept of broker knowledge becoming insurer's knowledge is not applicable. The plan supervisor names itself as broker of record, pays the broker promptly, and prepares the year-end Form 1099.

There is always a risk that the broker's knowledge becomes the insurer's knowledge, potentially creating legal liability

When paid directly by the stop-loss carrier, the broker signs the application as broker of record, and there is always a risk that broker's knowledge becomes insurer's knowledge. This is essentially the reverse of being paid through the plan supervisor, where the broker is insulated from the stop-loss transaction.

The sales commission should be shown as a percentage of premiums, presented in writing prior to the transaction, and receipt must be acknowledged by the plan fiduciary

PTE 84-24 requires that commissions be: (1) clearly stated in writing to the plan fiduciary before the transaction, (2) presented in an understandable format, (3) affiliate relationships disclosed, (4) sales commission shown as a percentage of premiums, (5) adjustments including production bonuses shown, and (6) receipt acknowledged by the plan administrator.

No party in interest may be paid a commission on a transaction involving a plan asset, and a stop-loss agreement will usually be a plan asset

ERISA prohibits a broker (who is assumed to be a party in interest for that transaction) from being paid a commission on a transaction involving a plan asset (which a stop-loss agreement will usually be). PTE 77-9 was promulgated in 1977 and later amended by PTE 84-24 to provide exemptions to avoid market disruption.

Six years

The agent must retain records for the ERISA-required six-year period, with these records explaining any commissions paid on plan asset insurance transactions. This retention period is specified in the course's discussion of PTE requirements.

Because the broker's role is purely ministerial, offering no service to the plan, so the plan or employer as fiduciary is responsible for deciding which quote is best

A Class A broker is only asked to provide a single stop-loss quote without being tasked to shop for options or assess quality and price. The broker's role is purely ministerial. Since the broker is not providing a service to the plan beyond this mechanical task, it is not considered a party in interest.

A Class B broker actively shops the market, compares options, and may provide recommendations, thereby offering a service to the plan and becoming a party in interest

A Class B broker actively shops the market for stop-loss coverage, compares options, and may provide recommendations. By providing these services, the broker is offering a service to the plan and thus becomes a party in interest. This moves the broker's actions beyond the mere ministerial execution role of a Class A broker.

The employer is the owner, applicant, payer, and beneficiary; no participant contributions are permitted; and the stop-loss provides no security for plan benefits

DOL Advisory Opinion 92-2A states that the stop-loss agreement is not a plan asset if: (1) the employer is the owner, applicant, payer, and beneficiary; (2) no participant contributions to the healthcare plan are permitted or allowed; and (3) the stop-loss provides no security for plan benefits and no reference to stop-loss should be made in ERISA documents in a way suggesting it is part of the plan.

An audit by an independent accountant is required, bonding in the amount of 10% of the annual stop-loss premium is required, and commissions on stop-loss premiums must be disclosed

If the stop-loss is a plan asset, three events must follow: (1) an audit by an independent account is required for plans over 100 participants; (2) bonding in the amount of 10% of the annual stop-loss premium is required; and (3) commissions on the stop-loss premiums must be disclosed.

Convert the plan from a contributory plan to a noncontributory plan or implement an IRC Section 125 premium conversion plan

The employer may be inspired to convert the plan from a contributory plan to a noncontributory plan or to put in place an IRC Section 125 premium conversion plan to avoid the possible fallout from DOL Advisory Opinion 92-2A, which could classify the stop-loss as a plan asset in a contributory plan.

The A/P is cleared out only when a claims invoice is presented; no participant monies may be used except to pay claims

In the general asset plan methodology, the $100 participant contribution is booked to A/P Participant Contributions and cleared out only when a claims invoice is presented. No participant monies may be used except to pay claims. By following this discipline, the stop-loss agreement will not become a plan asset.

A plan asset will be created and the funding methodology must be changed, either by setting up a participant contribution trust or by using participant contributions to pay fixed costs

Where claims fail to exceed participant contributions on a plan year basis, a plan asset will be created and the funding methodology must be changed. Options include: (1) set up a participant contribution trust, or (2) use participant contributions to pay fixed costs such as stop-loss premiums. Either approach addresses the ERISA compliance issue.

Profit-sharing bonuses paid to a plan supervisor based directly or indirectly on the claims experience of the group

Any arrangement by which a plan supervisor is paid a bonus based directly or indirectly on the claims experience of the group violates state administrator laws and may violate ERISA Section 510 dealing with interference of the rights of plan participants. Such bonuses are not acceptable compensation, whether or not disclosed.

Only when the person is not a fiduciary as regards the stop-loss placement (Situation B), or when the stop-loss is not a plan asset, though traditional business ethics still apply

ERISA Section 406 would prohibit a fiduciary (Situation A) from accepting an inducement. However, if the person is not a fiduciary regarding the stop-loss placement (Situation B), the inducement is acceptable. If the stop-loss is not a plan asset, no ERISA restrictions apply, though traditional business ethics remain.

No, a Class B broker cannot accept the inducement because they are considered a party in interest with fiduciary duties regarding the placement

Figure 2-4 in the course shows that personal inducements are not acceptable for Class B or Class C brokers. A Class B broker shops the market and provides recommendations, making them a party in interest. Only a Class A broker (purely ministerial role) may accept inducements when stop-loss is a plan asset.

A conventional group life insurance plan

A plan of retired lives reserves is used to prefund post-retirement death benefits and must be an adjunct to a conventional group life insurance plan. It may be self-funded, funded with the guarantees of an insurer, or a combination of the two.

The employee is not taxed except for the cost of coverage in excess of $50,000, less any employee contribution

Under the retired lives reserves rules, the employee is not taxed except for the cost of coverage in excess of $50,000, less any employee contribution. The plan must also be nondiscriminatory, and contributions must be deductible as business expenses.

Retired key employees are taxed on the actual cost of coverage rather than Table I costs, and have no exclusion at all if the plan is discriminatory

DEFRA decreased the tax advantages by requiring that retired key employees be taxed on the actual cost of coverage rather than by Table I costs (formerly PS 58 costs). Furthermore, a retired key employee has no exclusion at all if the plan is discriminatory. These rules went into effect for individuals retiring after January 1, 1986.

Nondiscrimination rules discourage the plan for most smaller employers where key persons are usually involved

The course lists several obstacles: (1) high taxable income for coverage over $50,000; (2) burden of constructive receipt rules; (3) nondiscrimination rules discouraging the plan for smaller employers where key persons are involved; (4) severe excise tax penalties for disqualified benefits; and (5) lack of consistency in law and IRS positions.

The commitment to retiree health benefits would not outlive the collective bargaining agreement

While some courts ruled that retiree benefits were not to be terminated unless clear evidence indicated a contrary intention, and one held the commitment outlived the employer, a more employer-favorable court decision held that the commitment to retiree health benefits would not outlive the collective bargaining agreement.

Through a separate IRC Section 401(h) account under a pension plan, or through a welfare benefit fund under IRC Section 419 or a limited qualified asset account under IRC Section 419A

Under current law, prefunding of post-retirement medical benefits can be accomplished through (1) a separate IRC Section 401(h) account under a pension or annuity plan, or (2) through a welfare benefit fund (IRC Section 419) or a limited qualified asset account (IRC Section 419A).

The 20% or 50% tax penalty on reversion upon pension plan termination does not apply to any asset transferred to an IRC Section 401(h) account to pay retiree health benefit liabilities

Under the Revenue Reconciliation Act of 1990, the tax penalty (either 20% or 50%) on reversion on termination of a pension plan does not apply to any asset transferred to an IRC Section 401(h) account to pay retiree health benefit liabilities. This makes the 401(h) account especially attractive for employers with overfunded pension plans.

The medical insurance protection, along with any life insurance protection, must be incidental—not more than 25% of the retirement benefits

The 401(h) separate account requires that the medical insurance protection, along with any life insurance protection, must be incidental—meaning not more than 25% of the retirement benefits. This ensures the primary purpose of the pension plan remains providing retirement income.

The remaining assets must revert to the employer and not to the retired employees; forfeited individual benefits must reduce the employer's future contributions

The 401(h) account must provide that upon satisfaction of all plan liabilities, remaining assets will revert to the employer and not to the retired employees. If an individual's medical benefits are forfeited, the forfeiture is applied to reduce the employer's future contributions for post-retirement medical benefits.

They require the immediate accrual of post-retirement benefits as soon as they are earned by employees, rather than recognizing them in the year they are paid after retirement

FASB's rules (ASC 715-60) had a dramatic effect by requiring the immediate accrual of post-retirement benefits as soon as they are earned by employees. Prior to these rules, employers could keep these liabilities off their balance sheets by recognizing them only when paid after retirement (pay-as-you-go basis).

No more rapidly than on a level basis over the working lives of the employees with the employer

Amounts may be accumulated in the reserve so that funding of post-retirement medical benefits can be completed upon the retirement of employees. However, these amounts may be accumulated no more rapidly than on a level basis over the working lives of the employees with the employer.