Enhanced Pension For Health Plan Waiver Equals Coverage Reduction

>The reduction of retiree coverage falls within the meaning of Section 420(c)(3)(E) of the Internal Revenue Code, the Internal Revenue Service (IRS) said in Revenue Ruling 2004-65.   The IRS based its decision on reading the applicable statues as they apply to an employer action to reduced retiree health coverage.

>To better illustrate the case for plan sponsors, the IRS provides a scenario in which an employer maintains a defined benefit plan that contains a retiree health benefits account.   As the plan is established, the company can opt to make qualified transfers of excess pension assets from time to time to fund applicable health benefits and for purposes of this illustration, a transfer of pension assets is done at the end of the plan year in 2002.   At the beginning of 2004’s plan year, the employer makes an offer to retirees covered under the plan to receive enhanced pension benefits in return for waiving their applicable health benefits.

The major issue with the offer is found Section 1.420-1 of the Income Tax Regulations.   This section offers plan sponsors guidance on determining what constitute “significantly reduced retiree health coverage during the cost maintenance period.”   Per the regulations, there is a significant reduction if:

• the employer-initiated reduction percentage for any taxable year beginning on or after January 1, 2002 exceeds 10%, or 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 employer-initiated reduction percentage for any taxable year equals the number of individuals (retired employees plus their spouses and dependents) receiving coverage for applicable health benefits as of the day before the first day of the taxable year whose coverage for applicable health benefits ended during the taxable year by reason of employer action, divided by the total number of such individuals receiving coverage for applicable health benefits as of the day before the first day of the taxable year.

Additionally, Section 1.420-1(b)(4) offers guidance for determining an employer-initiated reduction percentage in the context of an “employer action.”   Per this section, eligibility for retiree health benefits ends by reason of employer action if the individual’s eligibility for applicable health benefits ends as a result of a plan amendment or any other action of the employer that has the effect of ending the individual’s eligibility.

Applying these, and other standards to the present case,the IRS finds “if a covered individual accepts the offer to waive such coverage, the cessation of coverage will be treated as an employer-initiated reduction in coverage for purposes of determining whether the employer has significantly reduced retiree health coverage during the cost maintenance period.”

A copy of the Revenue Ruling is available at  http://www.irs.gov/pub/irs-drop/rr-04-65.pdf .