The term “419(e) plan” refers to a plan that qualifies under paragraph (e) of Section 419 of Internal Revenue Code, which provides for the treatment of funded welfare benefit plans.
A 419(e) plan is an employee benefit program that is sponsored by the employer and which provides welfare benefits to its participants. All of the employee benefits are paid for by the same company. There is no pooling of benefits among the employees of various companies. Since Welfare Benefit Plans are for the benefit of employees and the business owners, the assets in the plan should not normally be available to creditors of the business.
The plan typically involves an independent trustee that holds the trust assets, and a third-party administrator that arranges actuarial certification of funding and benefits and approves plan administration.
Cash contributions are made irrevocably to the trust without the possibility of reversion. They are determined actuarially based on an annual census using projected retirement ages of all employees and projected medical costs from retirement through actuarial death. The sponsoring employer may choose a target contribution or a target benefit. Contributions on behalf of key employees are kept separate from contributions for rank-and-file.
This type of plan allows a company a suite of benefits to its employees – including the owners of the business – ranging from death benefits during their working years to medical and long term care benefits in retirement. Essentially, the goal of a 419(e) plan is to allow the company to pre-fund certain retirement benefits in advance; thus, larger contributions may be made to the plan in the early years.
The employer is allowed to decide which benefits to provide to employees. New benefits may be coordinated with existing employee benefits, and new benefits that supplement the existing benefits may be offered.
One of the more popular benefits of 419(e) plans is post-retirement medical benefits. These benefits provide funding for health expenses incurred during retirement. Employees do not vest in the benefits, but instead become eligible when they reach a retirement age set by the employer.
The welfare benefits provided by a 419(e) plan are meant to enhance the financial security of employees and can include:
- Supplemental Disability Benefits
- Severance Benefits
- Post-Retirement Medical Benefits
- Long Term Care Benefits
- Death Benefits
If you will need certain welfare benefits through retirement anyhow, a 419(e) plan allows you to essentially pay for those benefits in advance and obtain a substantial current-year tax deduction. Some 419(e) plans additionally pay death benefits on behalf of current employees and add substantial medical benefits for retirees. The medical benefits can include reimbursement for amounts paid for medical, dental, and psychological care, prescription and over-the-counter drugs, long term care services, nursing home care, home care, premiums for medical, dental, Medicare and long term care coverage and more.
Non-discriminatory rules apply except employees do not vest until actual retirement at a defined retirement age. Contributions to plans compliant with section 419 are deductible by the employer to the extent permitted by law. Distributions in the form of medical expense reimbursements are not taxable income.
The downsides of 419(e) plans include that, depending on what the benefit provides, the contributions to the plan might not be fully deductible (such as where death benefits are provided) and discrimination among employees might not be allowed (such as where medical benefits are provided). Also, these plans are somewhat complex and require the services of an actuary who is experienced in these plans to correctly implement.
Nonetheless, 419(e) plans are good for businesses that desire to tailor an employee benefit plan to their specific needs or which need flexible funding options. The plans may also be structured to provide valuable incentives to employees to remain with the company.
The benefits of Welfare Benefit Plans include:
- The employees benefit: The employee has the comfort of knowing that his family is protected in case of untimely death while covered and has the comfort of knowing that much of his medical needs in retirement — and the needs of his spouse and dependents — are met, including long-term care.
- The owner-employees benefit: Like all employees the owner-employee has the comfort of knowing there is a death benefit and medical benefit awaiting the owner and the owner’s family as a before-tax expense of the company.
- The company benefits: The company can offer valuable benefits to reward valued employees at affordable costs; benefits formerly offered only by large employers which are now available to small and mid-size companies; it can use these benefits as “golden handcuffs” to stem turnover of expensively trained and valuable employees; its contributions are deductible so long as the rules of §419 and §419A are met, in other words contributions are more affordable with before-tax dollars to the extent deductible.
- A company that wants to offer supplemental benefits: Companies looking to reward their most important employees – the owners and executives – are often limited in the amount that can be contributed to plans for their benefit, particularly retirement plans. A Welfare Benefit Plan can offer additional benefits for these employees, such as family protection and retiree medical benefits, without limitations as long as actuarially reasonable.
- Post-retirement medical accounts are not vested and only become available for use by an employee when retirement age is reached while still an employee. Amounts forfeited due to termination of employment are retained by the plan.
In summary, 419(e) welfare benefit plans offer significant advantages to farsighted business owners and their employees, with a substantial portion of the offered benefits being currently deductible to the business. When correctly structured, they allow the business to pre-fund valuable post-retirement and other welfare benefits for employees.
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