September 2003

Benefits of Forming a Voluntary Employees Beneficiary Association

By Lance Wallach

Although they have been in existence since 1928, Voluntary Employees Beneficiary Associations (VEBA) are not well known or understood. VEBAs allow an employer that joins to receive a current tax deduction while putting away funds that are not currently needed. A VEBA allows the employer a great deal of latitude in choosing plan benefits. Contributions are tax-deductible and funds grow tax-deferred. VEBAs have no penalties for early distributions, and life benefits can pass to the employee’s family free of income, estate, and gift taxes. A VEBA can be designed so that the benefits paid are not subject to estate taxes because participants have no “incidents of ownership” in the assets, including life insurance contracts held under the VEBA.

VEBA assets are protected from the claims of creditors, the amounts in which contributions are made can be flexible, and benefits are highly favorable to the business owner, with no vesting for employees. Additionally, a VEBA can supplement or enhance buy/sell and stock-redemption agreements, or solve retained earnings problems.

Almost any business can establish a VEBA for its employees, including owner-employees. An employer with one employee (including a spouse) can establish a VEBA. A VEBA is a tax-exempt organization, as described under IRC section 501(c)(9), and would receive a tax-exemption letter from the IRS. An employer can maintain both a retirement plan and a VEBA. VEBAs typically provide for the payment of life insurance, accident insurance, sickness, and other benefits to the members of the VEBA or their dependents and beneficiaries.

VEBA trust earnings are tax-exempt while the trust is accumulating funds. An employer can join an existing multiemployer VEBA.

In most cases, a VEBA is set up as a trust with a bank as the trustee. Some trusts look like VEBAs but are not because the trust sponsor has not taken the additional, costly, step of filing the trust with the IRS under IRC section 501(c)(9).

The IRS has recently taken decisive action against abusive plans claiming to be in conformance with IRC section 419A(f)(6) plans. Under Treasury Decision 9000, the disclosure requirement was extended to include participants. All employers and participants in an IRC section 419(f)(6) arrangement will be required to attach a notification to their tax returns disclosing their participation in a “listed transaction.” In addition to the potentially devastating financial ramifications, failure to disclose such participation to the IRS carries criminal penalties.

VEBAs are subject to some Employee Retirement Income Security Act of 1974 (ERISA) rules but are not subject to the rules governing qualified plans. Therefore, VEBA termination can be made prior to age 59!s without subjecting the distributee to the 10% early distribution penalty. In addition, VEBA distributions are not required to begin by the time the participant reaches age 70!s. VEBAs permit employers to deduct contributions to the trust much greater than those available for qualified plans.

Another advantage of the VEBA to the employer-owner is that upon termination all plan assets are distributed to the active participants as of the date of the termination. As a result, there is no vesting to employees that have left the service of the employer.

A VEBA allows more tax-deductible contributions than a 401(k) plan because it is not subject to strict pension plan guidelines. Contribution limits are based on “reasonableness.” In 1992 the Tax Court allowed a $1.1 million VEBA tax deduction that covered two people.

A VEBA is well suited to a business that—

Lance Wallach, CLU, ChFC, CIMC, of Plainview (Long Island), New York, can be contacted through www.vebaplan.com.

Sheldon M. Geller, Esq.
Geller & Wind, Ltd.

Mitchell J. Smilowtiz
Charles W. Cammack Associates, Inc.

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