Employers increasingly offer retiree health coverage through health reimbursement arrangements (HRA), which help their employees cover plan-eligible medical expenses during retirement.
Employer premium payments are generally exempt from taxes, helping employees keep costs for health insurance at bay after tax payments. But is this exemption permanent?
Taxes on Premiums
Employer contributions toward retiree health insurance premiums typically aren’t taxable because most group health plans are funded by businesses; thus, employee payments for premiums deducted directly from wages before being reported on tax returns.
Tax treatment of retiree health insurance premiums depends on the details of each plan and whether it meets minimum value coverage standards. For instance, employers may offer health reimbursement arrangements (HRA), an account designed to reimburse medical expenses. If this HRA meets minimum value requirements then its usage could enable purchasing an individual market policy without losing eligibility for premium tax credits.
Recent trends indicate fewer employers are providing retiree health benefits due to various factors: rising health insurance costs; economic cyclical changes; legislative changes such as the Deficit and Economic Recovery Act of 1984 (which reduced prefunding tax advantages); as well as Financial Accounting Standards Board’s new accounting standards for accounting benefits for retirees.
Even with these trends in place, firms that provide retiree health benefits still exist. Many such firms are in the public sector and offer coverage regardless of age or sex for all employees – including domestic partners of retired workers – although this practice is rare.
Public safety plans provide former employees the ability to exclude from income distributions made from an eligible retirement plan that are used to pay for accident and health insurance and long-term care insurance from income. This option is open to anyone working within public safety – law enforcement officers, firefighters, paramedics as well as members of rescue squads or ambulance crews are eligible.
Because of the Affordable Care Act (ACA), it is now possible to purchase a benchmark plan through the individual marketplace and receive premium tax credits if your income falls within 400% of poverty level. However, if you’re already covered under an employer-sponsored plan that meets both minimum value and affordability standards then no premium subsidy for benchmark plans will apply to you.
Taxes on Benefits
Retiree benefits such as health insurance premiums paid by an employer are generally subject to taxes, regardless of whether they were earned through after-tax wages or pre-tax dollars. Although tax on after-tax health insurance benefits tends to be less substantial than on taxable wages, especially among workers in higher tax brackets.
Employees can take advantage of the federal tax break for health care costs by having the portion of their salary that goes toward health insurance premiums paid through FedFlex or similar programs converted to pre-tax money and converted back into federal income taxes and FICA payroll taxes – the latter funding Social Security and Medicare. Depending on an individual’s situation, converting this benefit could also allow them to avoid state income taxes altogether.
Some employers provide retirees with health reimbursement arrangements that reimburse medical expenses through salary reduction contributions, rather than via salary reimbursement plans or health savings accounts (HSAs). Such plans do not fall under federal tax rules for cafeteria plans and HSAs; rather they fall under section 125 rules applicable to flexible spending accounts or health reimbursement accounts; the IRS has published several rulings about such arrangements that may help employees better understand how they’re taxed.
One key aspect of health reimbursement arrangements is their need to cover only substantiated medical expenses – not routine wellness visits or other health costs – with each expense not exceeding an annual limit set by the IRS. Rev. Rul. 2002-41 describes one such health reimbursement agreement which fulfills these criteria.
Employers that pay premiums for family health coverage to their retired employee in exchange for “imputed service” over nine years must consider it as taxable income in the year of retirement, even though making such payments from post-tax money would have saved FICA and Medicare taxes.
Taxes on Distributions
Retiree health benefits can be an essential perk of employment. Unfortunately, due to various circumstances, some companies have begun cutting back their offers of these benefits for retirees. Declines in coverage could be attributable to cyclical fluctuations; financial impact from retiree health costs on firms’ income statements due to new accounting rules adopted by the Financial Accounting Standards Board; or legislative reforms that reduce prefunding retiree healthcare costs (Employee Benefit Research Institute 1997). Other potential contributors could include an increasing perception among workers that retirement should be seen as an opportunity to relax and focus solely on enjoying their lives, the shift toward flexible workplaces that offer less generous retiree health benefits, or any attempts at encouraging early retirement.
Employers, particularly larger ones, have responded by adopting cost-containment strategies in the form of reduced plan benefits or increasing worker contributions. One common cost-cutting measure involves giving retirees access to a private exchange on a non-group basis and/or health reimbursement accounts (HRA) so they can reimburse themselves for medical expenses directly. Some firms even mandate that retirees purchase prescription drug coverage out-of-pocket rather than through their plan.
Distributions from an eligible retirement plan to pay accident, health and long-term care insurance premiums do not have to be reported as income by retired employees or their beneficiaries, provided the payments are made directly by them to insurers in order to cover them as beneficiaries for themselves and/or their spouse and/or children. Excluded amounts cannot exceed $3,000 of what was actually spent for insurance policies purchased for themselves and/or others.
IRS regulations allow individuals to exclude from gross income the portion of their pension from which distributions are received to cover health insurance costs. This provision applies to 401(k) plans and government employer pension or welfare benefit funds that provide such coverage; they do not, however, extend to public safety officers’ 401(k) accounts due to changes in tax law; under prior tax legislation this distribution was exempted from taxable income when received for themselves and family members.
Taxes on Death Benefits
Insurance and pensions play an integral part in American economic well-being, from life insurance to health benefits and pensions. Both can help offset risks individuals cannot manage on their own – such as an unexpected event causing financial loss or unexpected medical costs during retirement – mitigating risks individuals can’t afford to cover on their own. Each benefit has different tax provisions which could impact how you plan for retirement and determine your insurance needs.
Depending on the plan of your former employer (such as Civil Service Retired Employees Association Plan) and whether they paid incidental death benefits during your lifetime, when you die your beneficiary will receive a payment subject to federal taxes which will be withheld unless it’s transferred over into another qualified retirement account; state taxes may also be withheld as applicable.
As a general rule, amounts held in qualified retirement plans to pay accident or health insurance premiums are generally taxable distributions subject to certain statutory exceptions. Recently, the IRS released final regulations regarding how they should be taxed.
These rules apply to qualified pension, profit-sharing and stock bonus plans as well as individual annuities and deferred compensation plans that meet the criteria set out in section 401(a) of the Internal Revenue Code, while not being treated as trusts under section 402(a).
The final rules permit participants in these arrangements to elect to have their premiums paid pretax by their plan, thus lowering taxable distributions and potentially “double dipping.” However, these rules prohibit members from “double dipping” by also claiming these premiums as medical deductions on Schedule A of Form 1040; rather they already deducted as part of gross wages from taxable income.
