Health Waiver Results In Reduced Coverage

Section 420 of the Internal Revenue Code allows an employer to transfer surplus pension assets to a separate account to pay for current retiree health benefits. When individuals entitled to those health benefits accept their employer's offer to waive them in exchange for enhanced pension benefits, the employer has effectively reduced retiree health coverage and, as a result, could potentially violate Section 420, the Internal Revenue Service (IRS) has said in Revenue Ruling 2004–65.

To illustrate its point, the IRS provides a scenario in its ruling in which an employer maintains a defined benefit plan that contains a retiree health benefits account. From time to time, the scenario notes, the company makes qualified transfers of excess pension assets to fund applicable health benefits. One such theoretical transfer occurs on June 30, 2002. Then on July 1, 2004, the employer offers plan participants the opportunity to receive enhanced pension benefits in return for waiving their applicable health benefits.

At issue with the waiver, the IRS notes, is determining what constitutes "significantly reduced retiree health coverage during the cost maintenance period." According to IRS regulations, a significant reduction occurs if the employer-initiated reduction exceeds 10% during the cost maintenance period for any taxable year beginning on or after Jan. 1, 2002, or if the sum of the employer-initiated reduction percentage for that taxable year and all prior taxable years during the cost maintenance period exceeds 20%.

The IRS also provides guidance for calculating the reduction percentage: divide the number of people who waived their health benefits by the total number of people receiving benefits as of the day before the first day of the employer's tax year.

A copy of the IRS Ruling can be found at: http://www.irs.gov/pub/irs-drop/rr-04-65.pdf.