October 19, 2005
More on Post-Death Access under HRA Plans
This alert updates the alert we previously issued on April 13, 2005 regarding IRS Notice 2004-24 (the “Notice”). The Notice identified three specific types of plan designs that do not qualify as health reimbursement arrangements (“HRAs”). In other words, three plan designs were identified and discussed that were not subject to favorable tax treatment; contributions and any earnings would be taxable. The prior alert described the three plan designs as follows:
- Providing payment of cash equal to all or a portion of a participant’s unused reimbursement amount at the end of the plan year or upon termination, even if such payment is treated as taxable compensation;
- Providing payment of cash equal to all or a portion of the unused reimbursement amount to a designated beneficiary or the participant’s estate upon the participant’s death; and
- Coordinating with an “option plan,” purportedly separate from the reimbursement plan, pursuant to which amounts forfeited under the HRA are paid in cash or contributed to a retirement plan.
Clarification. Based upon subsequent conversations with the IRS National Office, it is our understanding the IRS believes situation 2 clarifies that following the account holder’s death, access to the account may only be provided to a surviving spouse and dependents. In other words, the plan cannot provide post-death access to a designated beneficiary (other than the surviving spouse and dependents) even if the access is limited to reimbursement of medical expenses and treated as a taxable event for the designated beneficiary.
Our understanding was recently confirmed by the IRS when this firm submitted a Private Letter Ruling (“PLR”) request for a post-employment medical reimbursement plan that provided post-death access to a designated beneficiary where there was no spouse or dependents. The access was limited to medical expense reimbursement of the designated beneficiary and all distributions would be taxable income to the recipient designated beneficiary. We were provided the opportunity to withdraw PLR request. We were squarely informed that if the IRS issued a ruling it would indicate that the proposed plan was not an HRA. Among other reasons, it allowed post-death access by a designated beneficiary other than a surviving spouse and dependent.
Transitional Relief. The Notice issued in April provides plans with “issues” until the start of the first plan year beginning after December 31, 2005 to make the necessary adjustments. In response to our direct question, this transition period includes changes that must be made with respect to post-death access by other than a surviving spouse and dependents. Thereafter, plans with programs that do not comply with the guidance provided by the IRS in the Notice will be viewed as non-compliant; not HRAs.
Action Steps. In light of the IRS informal comments regarding what it believes it addressed in the Notice, we recommend the following:
- Employers sponsoring HRAs should review the terms of their plans to determine whether they contain any of the design features prohibited by the Notice, including post-death access by a designated beneficiary other than a surviving spouse or dependent.
- If such features exist, the plan must be amended prior to the start of the plan year beginning after December 31, 2005. [For calendar year plans, the amendment must be made prior to January 1, 2006.] For plans with other plan years (i.e., July 1 through June 30), the amendment must be made prior to the start of the 2006 plan year.
- Employers whose HRA documentation is provided by a vendor should contact the vendor immediately to ensure the vendor is taking the steps necessary to have the plan amended in a timely manner.
If you need assistance determining whether your HRA complies with the Notice and/or preparing the necessary amendment to the plan, please contact us.