Questions and Answers regarding Single Employer Welfare Benefit Plans

What is a Single Employer Welfare Benefit Plan (SEWP)? What is a welfare benefit?

As its name implies, a Single Employer Welfare Benefit Plan is a plan established by an employer to provide welfare benefits for its eligible employees. Welfare benefits are defined in Internal Revenue Code §419(e), and generally are benefits of "present interest," i.e., those benefits that protect against loss from such unanticipated events as illness, accident or death, or that safeguard an employee's (and his/her family's) well-being. Such benefits may take the form of cash compensation, or non-cash insurance benefits (e.g., medical or nursing services). Child care facilities, for example, are also welfare benefits, because they safeguard the well-being of both the employee and his/her dependent(s).

Can retirement benefits be considered welfare benefits?

No. And this is a key distinction. As noted, welfare benefits, with a couple of specific statutory exceptions,¹ operate to protect employees in the present. Retirement benefits are benefits of "future interest," and are distinct from welfare benefits because they contemplate a planned event to take place at a specific future time (and generally may not be accessed for present use), and they involve ongoing preparation for the future event. Neither a "qualified" retirement plan (pension, profit-sharing plan, etc.) nor a "non-qualified" deferred compensation plan can be considered a welfare plan.

In the past, we've heard a great deal about "multiple-employer" plans. What is the difference between a single-employer plan and a multiple-employer plan?

There are several differences. The most obvious, of course, is that the single employer plan is sponsored by one employer for its employees. The multiple-employer plan is sponsored by at least ten employers (but practically speaking, many more), and, according to regulations, requires a pooling of assets to provide benefits for all participating employees of all participating employers.

Most multiple-employer plans established after 1984 were set up in order to take advantage of an exemption from the rules of Sections 419 and 419A, which basically limited tax-deductible contributions and accounts accumulated to pay benefits. Single-employer plans are designed to comply with those limits.

According to the law's intention, no employer could exercise control or undue influence over a multiple-employer plan, and if an employer withdrew from such a plan, the plan continued (i.e., there was no "plan" termination). If an employer terminates its participation in a single-employer plan, the plan ends.

Finally, because they seek no exemption from the limits imposed by §§419 and 419A, SEWPs do not have to satisfy the criteria which would qualify them for the exemptions (under either §419A(f)(6) or §419A(f)(5)(A)). They do need to qualify contributions and asset accounts under the limits imposed by §§419 and 419A.

What are the tax effects of a SEWP?

§419 of the Code governs whether employer contributions to a SEWP are deductible. The section provides that such contributions must meet the "ordinary and necessary" requirements of §162 AND constitute a "qualified cost" of providing the benefit. §419(b) defines qualified cost as the sum of the "qualified direct cost" (§419(c)) plus annual additions to the plan's "qualified asset account (§419A)." The "qualified direct cost" is an amount would be deductible to the employer if it were a cash-basis taxpayer providing the benefit directly to the employees. The clearest thing about this definition is that, in many instances it is unclear, and engenders varying interpretations. What is assumed to be deductible is the reasonable cost to the employer of providing the benefit.

Most benefits in a welfare plan, SEWP or otherwise, are non-taxable to participants. Two exceptions are:

• disability income benefits to the extent funded by the employer (the participant's insured status does not create taxation, but when disability income is provided, it is taxable; and
• the current economic benefit provided by death benefits covering employees' lives. These benefits are measured by an annual renewable term rate, ether from a government table (Table 2001) or from the insuring company's lower rate, if that rate qualifies under IRS guidelines. In either case, this number is usually a small fraction of the employer's actual annual contribution for the benefit.

Death benefits paid to a participant's beneficiaries are generally income-tax free, and may, with proper arrangement, avoid inclusion in his/her taxable estate.

What is a VEBA? Is a SEWP a VEBA?

There is probably as much confusion around this issue as any in the welfare benefit arena. A SEWP is a plan. A VEBA is a fund. These are two entities that may interact, but are not the same. A Plan, such as a SEWP, provides welfare benefits to eligible participants. The fund is that part of the plan that is used as the vehicle to pay for benefits and store any asset accounts that are accumulated for the purpose of paying Plan benefits. It may be a taxable or a tax-exempt entity. A VEBA (Voluntary Employees' Beneficiary Association) is a tax-exempt fund, usually a trust.

Because of their tax-exempt status, more stringent rules apply to VEBAs than to taxable trusts.

VEBAs are subject to strict antidiscrimination provisions which, among other things, require compliance with inclusion rules regarding the determination of employee eligibility for benefits, limit the amount of income that a highly-compensated individual may include as a basis for calculating benefits, and strictly regulate the distribution of plan assets to participating employees.

The United Financial Group (UFG) has chosen to utilize a taxable trust to fund the SEWP that it promotes. Although prudent operation dictates that it follow some of the guidelines that apply to VEBAs, the fact that there is no restriction on the amount of an employee's income that may be included in the calculation of benefits makes a taxable trust the more workable and flexible fund. And inasmuch as the plan is funded exclusively with tax-deferred insurance company products, the perceived disadvantage of trust taxability is minimized.

What form(s) of business entity may sponsor a SEWP?

Virtually any form of business other than a sole proprietorship may sponsor a SEWP. SEWPs are employee benefit plans, and sole proprietors are neither employees nor independent contractors of their proprietorships, and thus are ineligible to receive benefits under a SEWP. Proprietors who are otherwise candidates for SEWPs might well consider establishing another form of business entity, such as an S-Corporation.

Must all employees of an employer be included in a SEWP?

Rules governing eligibility requirements are not as clear for plans funded with taxable trusts as they are for VEBAs, and it is often presumed that an employer may favor key employees more broadly in such plans in terms both of eligibility and benefits offered . But even if VEBA guidelines are followed either in whole or in part for the sake of safety, certain classes of employee may be excluded from eligibility, among them, part-time and seasonal employees, employees less than 21 years of age or with less than a specified number of years of service (the UFG-supported trust allows up to two years), or members of a collective bargaining unit, wherein benefits of this type have been the subject of good-faith bargaining at arms' length between representatives of the employer and the employee unit.

May a plan cover only one person?

Yes, if that person is the company's only employee, or at least the only employee who is not excludable under the categories noted above. However, according to DOL regulations, plans covering only employees who are owners of the employer do not enjoy certain protections afforded plans that include common-law employee(s).

May non-employees be covered?

Under certain circumstances, and for certain benefits, some non-employees may be covered. Immediate family members may be covered for health benefits. Some plans permit spouses to be provided with life benefits. And the term "employee" may be defined in a given plan to include retired employees.² Other non-employees, such as shareholders who do not perform employment-related services, may not be covered in the plan.

Who controls the SEWP?

The plan's independent trustee controls most functions of the SEWP, including administrative functions (which the trustee may delegate), investment decisions and when, whether and how much benefits are payable to plan participants. The employer does have the right to discontinue its participation in the plan, and in the case of a single-employer plan, such discontinuance is tantamount to plan termination.

May a SEWP discriminate in favor of key or highly-compensated employees?

This is another gray area. For plans funded with taxable trusts, there are no specific statutory guidelines relating to discrimination. And that leaves us with the question of whether or not plans may, or are even encouraged to discriminate.

We do not believe it was the intent of congress, in authorizing benefit programs explicitly intended for employees, to thereby sanction plans where the only employees eligible to be covered are those who also are owners of the employer. And in its attacks on varying types of multiple-employer plans in recent years, the IRS has made clear that the conditions it has sought to eliminate are those where plans benefit exclusively or primarily owners, and benefits to non-owners are either nonexistent or negligible.

Thus UFG has taken the position that the best plans are those that favor the key people without discriminating, or artificially skewing the plans in their favor. UFG's SEWP therefore emphasizes life benefits, where the natural income disparity, and usually the age disparity, between key and non-key employees creates a wide gap in the size of both contributions and benefits provided. The results typically show the great bulk of the contribution going to fund benefits for key personnel, while all employees receive meaningful, and proportionate benefits.

May contributions to a SEWP vary from year to year?

Contributions for certain death benefits are expected to be level-funded over the working lives of participating employees. Depending on insurance products used, however, such funding may still vary. The level-funding concept may calculate contributions based on level-funding forward to the target date as of each valuation date. Other factors, such employer's ability to fund contracts, as well as changes in the participating employee census as well as changes in costs of other benefits offered may all cause contributions to vary.

May a SEWP be used in lieu of a pension plan?

As noted above, SEWPs and pension plans (and other forms of deferred compensation as well) have different purposes. Their benefits most often complement one another, but neither should be used in place of the other.

What happens when a SEWP terminates?

Once again, as previously noted, a major distinction between a SEWP and a multiple-employer plan is that when an employer withdraws from a SEWP, the plan terminates. At that point, any benefits owed to participating employees are paid. To the extent that assets remain in the plan, and depending upon their nature, they may then be distributed to employees who are participants at the time of plan termination in the form of benefits (e.g., insurance policies), cash, or both. Such distributions should be proportionate to the benefits carried immediately prior to plan termination.

May any plan assets revert to the employer (i.e., the company)?

No.

What characteristics of a business make it a good candidate for a SEWP?

The following are essential:

1. The business must be financially sound;
2. Current ownership must anticipate remaining in business (or practice) for the next several years; and
3. The employer must accept the value to itself of providing meaningful benefits to non-key employees.

The following are highly desirable:

1. There is a wide gap in earned income between key and non-key employees;
2. Owners (and other key personnel) are significantly older than most non-key personnel;
3. There is a perceived need for additional business tax deductions; and
4. There are fewer than ten full-time employees.

¹The exceptions: IRC §419A(c)(2) authorizes the current funding of a separate reserve "over the working lives of the covered employees and actuarially determined on a level basis" to provide post-retirement medical and life insurance benefits, the for-mer to be funded based on current costs, and the latter limited to a $50,000 death benefit. No other "future interest" benefits are allowable as welfare benefits under the Code.

²IRC §419(g) provides a limited exception for situations where there is no employer-employee relationship, but the circum-stances are similar, i.e., where an independent contractor provides and is compensated for services to an entity that is not his/her employer, a plan may be established as if there were a relationship, and the service provider is considered the employee and the recipient of services is treated as the employer for the purpose of §419. UFG does not anticipate offering such plans at this time.