Pension plan's retiree medical account may fund tax-free HRA reimbursements

Plain-English summary

A bank maintained a qualified defined benefit plan with a separate section 401(h) account for retiree medical benefits. It also maintained an unfunded retiree-only health reimbursement arrangement that reimbursed eligible former employees and dependents for insurance premiums and other section 213(d) medical expenses. Because a VEBA trust then paying retiree benefits was expected to run out of assets, the bank proposed using the pension plan's section 401(h) account to reimburse qualifying HRA expenses. The IRS ruled that this use would not violate section 401(h) or cause the pension plan to lose qualified status, provided payments were limited to eligible retired employees, spouses, and dependents under the governing rules. It also ruled that the reimbursements would be excluded from recipients' gross income under section 105. Both rulings assumed that the retirement plan was otherwise qualified under section 401(a).

Ruling snapshot

• Question: May a qualified pension plan's section 401(h) account reimburse eligible retirees' HRA expenses without disqualifying the plan, and are those reimbursements excluded from income?
• Outcome: approved
• Key authorities: IRC §§ 105, 106, 213(d), and 401(a), (h); Treas. Reg. § 1.401-14; Rev. Rul. 2002-41; Notice 2002-45

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201805002                                             Third Party Communication: None
Release Date: 2/2/2018                                        Date of Communication: Not Applicable
Index Number: 105.00-00, 106.00-00,
              401.27-00                                       Person To Contact:
                                                              -----------------
------------------------------                                Telephone Number:
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--------------------------------------------                  Refer Reply To:
 ----------------------------------------                     CC:TEGE:EB:HW
                                                              PLR-115397-17
                                                              Date:
                                                              November 3, 2017




Legend

Taxpayer                  =    ----------------------------------

Year                      =    -------

Retirement Plan           =    ----------------------------------------------------------

Date 1                    =    -----------------

Year 2                    =    -------

Health Benefit            =    --------------------------------------------------------------
Plan

Retiree HRA               =    -------------------------------------------------------------------------------------
                               ------------------------

Dear ----------------------:

This letter responds to your April 28, 2017 ruling request, submitted by your
representatives, as supplemented by correspondence dated August 28, 2017, October
6, 2017 and October 16, 2017, requesting rulings concerning the tax consequences of
a proposed transaction under sections 105 and 401(h) of the Internal Revenue Code
(the “Code”) and their accompanying regulations.

The following facts and representations are submitted under penalties of perjury in
support of your request:

PLR-115397-17                                2

Taxpayer is a full-service bank with offices across the United States, providing
corporate, commercial, retail banking, and wealth management solutions. Taxpayer
was formed in Year 1 by a corporate integration.

Taxpayer maintained the Retirement Plan, a defined benefit plan qualified under section
401(a) of the Code. The Retirement Plan is a successor plan to a previous retirement
plan, and in connection with mergers and purchases involving the formation of the
Taxpayer, it was renamed multiple times. The name of the Retirement Plan was
changed to its current name effective Date 1.

The Retirement Plan was amended to add a retiree health account described in section
401(h) before the formation of Taxpayer. No employee contributions were required to
be made to the Retirement Plan 401(h) account. Taxpayer attests that the Retirement
Plan subsequently received a favorable determination letter from the Internal Revenue
Service. Taxpayer further represents that the section 401(h) account was not funded,
directly or indirectly, by a section 420 transfer and that neither the Retirement Plan nor
any of its predecessor plans allowed for or permitted employee contributions.

Until the beginning of Year 2, all eligible active employees and retirees (and eligible
dependents) could participate in the Health Benefit Plan. The Health Benefit Plan
eligibility provisions were changed beginning Year 2 to only provide coverage for active
employees and certain retirees, generally up to age 65. Non-insured retiree health
benefits under the Health Benefit Plan are currently being paid from a Voluntary
Employee Beneficiary Association (VEBA) trust. Taxpayer represents that it has been
projected that the VEBA trust assets will be depleted within five months of the ruling
request. Upon exhaustion of the VEBA trust, Taxpayer represents that a portion of any
monthly premium for coverage of or payment of claims on behalf of participating retirees
(and their covered dependents) under the Health Benefit Plan will be paid through the
section 401(h) account of the Retirement Plan to the extent that the participants qualify
as “retired employees, their spouses, or their dependents” under section 401(h) of the
Code and § 1.401-14 of the Income Tax Regulations (“Eligible Individuals”).

Taxpayer adopted a retiree-only Health Reimbursement Account Plan (“Retiree HRA”),
effective the beginning of Year 2. The Retiree HRA, established under section 105 of
the Code, reimburses former employees (and certain of their dependents) (the “Retirees
and their dependents”), who meet the Retiree HRA’s eligibility criteria, for premiums
paid for Medicare or individual health insurance coverage and for any other expense for
medical care as defined in section 213(d) of the Code. Retirees and their dependents
will be credited with an amount under the Retiree HRA if they enroll in at least one
individual medical, dental, or vision policy offered through a private retiree health
exchange chosen by Taxpayer.

Taxpayer proposes to use the Retirement Plan’s section 401(h) account to reimburse
the eligible expenses of Retiree HRA participants who qualify as Eligible Individuals.

PLR-115397-17                                   3

Taxpayer represents that it will amend the Retirement Plan to permit the Retirement
Plan’s section 401(h) account to provide for distributions to or on behalf of Retirees and
their dependents for expenses under the Retiree HRA. Taxpayer represents that no
portion of the section 401(h) account will be used to reimburse the expenses of anyone
who does not qualify as an Eligible Individual under the Retirement Plan.

Taxpayer further represents that:

   (1) The Retiree HRA is a health reimbursement arrangement (“HRA”), as defined in
       Notice 2002-45, 2002-2 C.B. 93;

   (2) The Retiree HRA will, at all times following its implementation as described in the
       ruling request, remain unfunded, and no retired employee who is an Eligible
       Individual will be entitled to any amount under the Retiree HRA in excess of the
       amount required to be reimbursed under the section 401(h) account;

   (3) Prior to the satisfaction of all liabilities to provide retiree health benefits, the funds
       in the section 401(h) account shall not be used or diverted to any purpose other
       than providing such benefits;

   (4) Until reimbursements are made under the Retiree HRA, all Retiree HRA related
       funds will remain in the section 401(h) account and, in the event of either the
       Retirement Plan or section 401(h) account termination, all such amounts
       remaining in the section 401(h) account after satisfaction of all liabilities to
       provide medical benefits will be subject to section 401(h) (including section
       401(h)(5)) and the excise tax on reversions pursuant to section 4980;

   (5) Taxpayer does not have a contractual obligation to fund the Health Benefit Plan
       or the Retiree HRA Plan and may amend or terminate its retiree health plans at
       any time;

   (6) Taxpayer will audit the reimbursements made by the Retiree HRA annually to
       ensure that only Eligible Individuals’ expenses are reimbursed from the
       Retirement Plan’s 401(h) account; and

   (7) Taxpayer will amend the Retirement Plan to prohibit discrimination in favor of
       officers, shareholders, supervisory employees or highly compensated employees
       in accordance with § 1.401-14(b)(2) of the Income Tax Regulations.

RULINGS REQUESTED

Taxpayer requests rulings that:

PLR-115397-17                               4

(1) Use of the Retirement Plan’s section 401(h) account to reimburse premiums for
Medicare or other health insurance coverage and other Code section 213(d) medical
expenses of Retiree HRA participants who are “retired employees, their spouses, or
their dependents” under section 401(h) and § 1.401-14 of the Income Tax Regulations
will not violate section 401(h) of the Code or § 1.401-14 of the Income Tax Regulations
or otherwise cause the Retirement Plan to lose its tax-qualified status under section
401(a) of the Code; and

(2) Reimbursements in accordance with the terms of the Retiree HRA of eligible health
plan premiums and section 213(d) medical expenses of Eligible Individuals that are
made from the section 401(h) account are excludable from the gross income of those
individuals under section 105.

LAW

Section 61(a)(1) of the Code and § 1.61-21(a)(3) of the Income Tax Regulations provide
that, except as otherwise provided in Subtitle A, gross income includes compensation
for services, including fees, commissions, fringe benefits, and similar items.

Section 105(a) of the Code provides that, except as otherwise provided in this section,
amounts received by an employee through accident or health insurance for personal
injuries or sickness shall be included in gross income to the extent such amounts (1) are
attributable to contributions by the employer which were not includible in the gross
income of the employee, or (2) are paid by the employer.

Section 105(b) provides that, except in the case of amounts attributable to (and not in
excess of) deductions allowed under section 213 (relating to medical, etc., expenses)
for any prior taxable year, gross income does not include amounts referred to in
subsection (a) if such amounts are paid, directly or indirectly, to the taxpayer to
reimburse the taxpayer for expenses incurred by him for the medical care (as defined in
section 213(d)) of the taxpayer, his spouse, his dependents (as defined in section 152,
determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and any
child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable
year has not attained age 27. Any child to whom section 152(e) applies shall be treated
as a dependent of both parents for purposes of this subsection.

Section 106 provides that gross income does not include contributions by the employer
to accident or health plans for compensation (through insurance or otherwise) to his
employees for personal injuries or sickness. Section 1.106-1 of the Income Tax
Regulations provides that the gross income of an employee does not include
contributions which the employee’s employer makes to an accident or health plan for
compensation (through insurance or otherwise) for personal injuries or sickness to the
employee or the employee’s spouse or dependents (as defined in section 152 of the
Code, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof),

PLR-115397-17                                   5

and any child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the
taxable year has not attained age 27.

Section 401(a) describes requirements for a qualified trust that is created or organized
in the United States and forms part of a pension plan of an employer that is for the
exclusive benefit of the employer's employees or their beneficiaries. Section 501(a)
provides in pertinent part that an organization described in section 401(a) is generally
exempt from income tax.

In pertinent part, section 401(h) provides that, under regulations prescribed by the
Secretary, and subject to the provisions of section 420, a pension or annuity plan may
provide for the payment of benefits for sickness, accident, hospitalization, and medical
expenses of retired employees, their spouses and their dependents, but only if --

(1) such benefits are subordinate to the retirement benefits provided by the plan,

(2) a separate account is established and maintained for such benefits,

(3) the employer’s contributions to such separate account are reasonable and
ascertainable,

(4) it is impossible, at any time prior to the satisfaction of all liabilities under the plan to
provide such benefits, for any part of the corpus or income of such separate account to
be (within the taxable year or thereafter) used for, or diverted to, any purpose other than
the providing of such benefits, and

(5) notwithstanding the provisions of subsection (a)(2), upon the satisfaction of all
liabilities under the plan to provide such benefits, any amount remaining in such
separate account must, under the terms of the plan, be returned to the employer.
Section 1.401-14(a) of the Income Tax Regulations provides that, under section 401(h)
of the Code, a qualified pension or annuity plan may make provision for the payment of
sickness, accident, hospitalization, and medical expenses for retired employees, their
spouses, and their dependents. The term “medical benefits described in section 401(h)”
is used in this section to describe such payments.

Section 1.401-14(b)(1) of the Income Tax Regulations provides that, under section
401(h) of the Code, a qualified pension or annuity plan may provide for the payment of
medical benefits described in section 401(h) only for retired employees, their spouses,
or their dependents. To be “retired” for purposes of eligibility to receive medical benefits
described in section 401(h), an employee must be eligible to receive retirement benefits
provided under the pension plan, or else be retired by an employer providing such
medical benefits by reason of permanent disability. For purposes of the preceding
sentence, an employee is not considered to be eligible to receive retirement benefits

PLR-115397-17                               6

provided under the plan if he is still employed by the employer and a separation from
employment is a condition to receiving the retirement benefits.

In Rev. Rul. 2002-41, 2002-2 C.B. 75, an employer sponsors an HRA that is paid for
solely by the employer and not through salary reduction contributions. The HRA
reimburses substantiated medical care expenses (as defined in section 213(d)) of
participating employees and their spouses and dependents (as defined in section 152)
up to a maximum annual reimbursement amount. Unused amounts from one coverage
period are carried forward to subsequent coverage periods. Participating employees
have no right to receive cash or any other benefit in lieu of medical expense
reimbursements. In Situation 2 of Rev. Rul. 2002-41, the maximum reimbursement
amount under the HRA that is not applied to reimburse medical care expenses before
an employee retires or otherwise terminates employment continues to be available after
retirement or termination for any medical care expense incurred by the former employee
or the former employee’s spouse and dependents. The ruling concludes that coverage
and reimbursements made under the HRA are excludable from the gross income of
participating employees under sections 106 and 105.

Notice 2002-45, 2002-2 C.B. 93, describes the tax treatment of HRAs. The notice
explains that a tax-favored HRA is an arrangement that (1) is paid for solely by the
employer and not pursuant to a salary reduction election or otherwise under a section
125 cafeteria plan; (2) reimburses the employee for medical care expenses (as defined
in section 213(d)) incurred by the employee or by the employee’s spouse or
dependents; and (3) provides reimbursements up to a maximum dollar amount with any
unused portion of that amount at the end of the coverage period carried forward to
subsequent coverage periods.

CONCLUSION

Based on the facts and representations provided by the Taxpayer:

(1) Use of the Retirement Plan’s section 401(h) account to reimburse premiums for
Medicare or other health insurance coverage and other Code section 213(d) medical
expenses of Retiree HRA participants who are “retired employees, their spouses, or
their dependents” under section 401(h) and § 1.401-14 of the Income Tax Regulations
will not violate section 401(h) of the Code or § 1.401-14 of the Income Tax Regulations
or otherwise cause the Retirement Plan to lose it its tax-qualified status under section
401(a) of the Code.

(2) Reimbursements of health plan premiums and section 213(d) medical expenses to
Eligible Individuals from the Retirement Plan’s section 401(h) account, and in
accordance with the terms of the Retiree HRA, are excludable from the gross income of
those individuals under section 105.

PLR-115397-17                                  7

These rulings are based on the assumption that Taxpayer’s Retirement Plan is qualified
under section 401(a).

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party, as specified in Rev. Proc. 2017-1, 2017-1 I.R.B. 1, § 7.01(15)(b).

This office has not verified any of the material submitted in support of the request for
ruling, and such material is subject to verification on examination. The Associate office
will revoke or modify a letter ruling and apply the revocation retroactively if there has
been a misstatement or omission of controlling facts; the facts at the time of the
transaction are materially different from the controlling facts on which the ruling was
based; or, in the case of a transaction involving a continuing action or series of actions,
the controlling facts change during the course of the transaction. See Rev. Proc. 2017-
1, § 11.05.

Except as expressly provided above, no opinion is expressed or implied concerning the
federal income tax consequences of any other aspects of any transaction or item of
income described in this letter ruling.

This letter ruling is directed only to the taxpayer who requested it. Code Section
6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

If you have any questions concerning this letter, please contact Karen Levin at (202)
317-5500.

                                       Sincerely,

                                       /s/

                                       Kevin Knopf
                                       Senior Technician Reviewer
                                       Health & Welfare Branch
                                       Office of Associate Chief Counsel
                                       Tax Exempt & Government Entities


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