Navigating the Complexities of VEBA Asset Reallocation: Comprehensive Tax and ERISA Fiduciary Considerations
Voluntary employees’ beneficiary associations (VEBAs) are tax-exempt entities under Section 501(c)(9) of the Internal Revenue Code designed to fund various welfare benefits, including retiree medical expenses, life insurance, disability benefits, and severance pay. Over the years, as organizations undergo changes in benefit structures, experience demographic shifts, see investment returns that outperform projections, or sustain lower medical costs than expected, many employers find significant asset accumulations within their VEBAs.
In some cases, these accumulations may exceed the Section 419A “qualified asset account” limit, resulting in unrelated business taxable income (UBTI). The reallocation of these assets can offer significant advantages, such as reduction or elimination of unrelated business income tax (UBIT), reduction of tax that will be assessed when the VEBA terminates, funds for benefit enhancements, lower administrative costs and burdens, and reduced future employer contributions. However, VEBA reallocations require careful and thorough examination of complex tax implications and, in many cases, fiduciary obligations under the Employee Retirement Income Security Act of 1974, as amended (ERISA).
Tax Implications
VEBAs can only provide life, sick, accident, or certain “other benefits” that are “similar” to life, sick, or accident benefits. No part of the net earnings of a VEBA can “inure to the benefit” of any individual other than via the payment of permitted benefits. As a result, a VEBA cannot distribute assets back to a contributing employer on dissolution or termination. A terminating VEBA could distribute VEBA assets among participants as taxable lump-sum payments, but in some cases few participants remain. As a result, reallocation may be an attractive alternative to terminating a VEBA because it can help ensure that a greater number of employees and retirees receive benefits.
One of the critical challenges in reallocating VEBA assets involves navigating the intricate IRS “tax benefit rule.” Under this rule, employers that have previously taken deductions for VEBA contributions earmarked for particular benefits may face income recognition if those assets are later repurposed to fund benefits substantially different from their initial intent. For example, reallocating funds originally intended to cover collectively bargained retiree health expenses to pay for non-collectively-bargained active employees’ medical benefits can potentially trigger taxable income due to different deductibility standards under Section 419A.
Moreover, an even more significant concern arises from Section 4976, which imposes a severe 100% excise tax penalty if the reallocation is classified as a “reversion,” meaning assets return directly or indirectly to the employer. The IRS has issued private letter rulings (PLRs) in the past that identified reallocations that were not considered reversions, such as amending VEBAs used for retiree health benefits to fund active employee health benefits and a merger of two VEBAs into a single trust to benefit all employees of two recently merged companies.
Unfortunately, PLRs only provide limited comfort levels since they apply only to the individuals requesting the PLR and are not binding on the IRS in other instances no matter how similar. Moreover, in 2020, the IRS curtailed the issuance of PLRs on this subject, leaving organizations without the ability to obtain clear authoritative guidance for their own situation. Employers must therefore tread carefully, often relying heavily on nuanced interpretations of existing statutes and previous IRS positions.
Fiduciary Responsibilities Under ERISA
To the extent the VEBA maintains assets of plans subject to ERISA, ERISA’s plan asset rules would apply to any reallocations. Fiduciaries should consider that asset reallocations align with plan document requirements (for example, whether such a reallocation is permissible under the plans) and ERISA’s exclusive benefit requirements. Likewise, fiduciaries should be mindful of potential prohibited transactions. Any perceived or actual benefit to employers or other parties at the expense of plan participants could lead to litigation, regulatory penalties, and in some cases personal liability.
Best Practices for Reallocation Decisions
Given these substantial risks, employers should adopt a structured and detailed approach when evaluating and executing VEBA asset reallocations.
- Rigorous Document Analysis. Employers should review all relevant VEBA governing documents, including trust agreements, plan documents, IRS correspondence, and historical contribution documentation, to ensure the reallocation is explicitly permitted and consistent with the stated purpose of the VEBA and ERISA fiduciary obligations.
- Extensive Tax Analysis. Detailed assessments by specialized tax advisors are important to evaluate potential income recognition and excise tax risks. Employers should closely analyze historical deductions, current IRS positions, past PLRs, and relevant case law to mitigate uncertainties and establish defensible positions. Proactively engaging external counsel and fiduciary advisors early in the process has become an industry standard practice, ensuring adherence to evolving regulatory frameworks and minimizing potential exposure.
- Structured Fiduciary Processes. Fiduciaries should document their compliance with ERISA obligations. Among other things, employers should consider whether plans might need to be merged as part of the VEBA reallocation.
- Exploration of Alternative Solutions. Employers should systematically explore permissible uses for surplus assets that minimize risk. This might include augmenting existing benefits, introducing additional welfare benefits consistent with original VEBA purposes, or potentially transferring assets to another qualified VEBA that aligns with similar objectives and participant demographics.
- Collective Bargaining Agreements. Employers will want to ensure that VEBA reallocations do not violate applicable collective bargaining agreements.
- Tax Liability Insurance. Employers might want to consider tax liability insurance given that the IRS is not issuing PLRs for VEBA reallocations currently.
Going Forward
Organizations considering VEBA asset reallocations should incorporate long-term strategies, emphasizing regular fiduciary training, continual monitoring of regulatory guidance, and periodic internal compliance reviews. Establishing clear governance structures, including dedicated oversight committees and independent fiduciary advisors, can further bolster compliance and fiduciary prudence.
Moreover, proactive participant engagement and transparent communication about any reallocation decisions foster goodwill and reduce potential litigation risks, supporting broader organizational objectives and stability.
Conclusion
Navigating VEBA asset reallocations requires a comprehensive, meticulous, and proactive approach to address the intertwined complexities of tax regulations and ERISA fiduciary responsibilities. Employers should prioritize extensive analysis, thorough documentation, and proactive governance measures to protect their organizations and fulfill their duties effectively.
The legal issues here are nuanced, and this advisory is intended to be a high-level summary only. If you have specific questions, please contact your A&B attorney (or Steve Mindy).
If you have any questions, or would like additional information, please contact one of the attorneys on our Employee Benefits & Executive Compensation team.
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