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General Nondiscrimination Tests Under Code Section 505

What VEBA nondiscrimination tests under Code Section 505 generally apply to benefits offered by Banks?¹

Benefits offered under a VEBA generally are subject to the following tests under Code Section 505:

VEBA Classification Test: Each class of benefits must be provided to a classification of employees that is set forth in the plan and which is found by the IRS not to be discriminatory in favor of highly compensated employees; and

VEBA Benefit Test: The benefit provided may not discriminate in favor of highly compensated employees.

Code Section 505 provides that life insurance and disability benefits will not fail the VEBA Benefit Test merely because the benefits available bear a uniform relationship to total compensation, or the basic or regular rate of compensation, of the covered employees.

Also, benefits that are subject to their own Internal Revenue Code nondiscriminiation tests, such as group term life insurance subject to Code Section 79, do not need to meet the two VEBA tests listed above, but rather must meet the special nondiscrimination standards specific to those benefits.

What employees may be excluded from the VEBA Classification Test?

For purposes of the VEBA Classification Test, the following employees may be excluded:

Employees who have not completed 3 years of service;

Employees who have not attained age 21;

Seasonal employees or less than half-time employees;

Employees who are included in a unit of employees covered under a collective bargaining agreement if the benefit involved was the subject of good faith bargaining between employee representatives and employers; and

Employees who are nonresident aliens and who receive no earned income from the employer that constitutes income from sources within the United States.

What compensation is taken into account for the VEBA Classification and Benefits Tests?

The annual compensation of each employee that may be taken into account for the purposes of providing benefits under these benefit plans may not exceed a dollar limit.²

What is the definition of a "highly compensated employee"?

A "highly compensated employee" generally is an employee who, in the preceding ("look-back") year earned more than a dollar limit³ or who in the current or preceding year, was a more than 5% owner. The group earning more than the dollar limit may be limited further if the employer adopts the top-paid 20% group election.

An "employee" for purposes of determining highly compensated employees includes former employees who were highly compensated in their year of separation from employment or during any year ending on or after the 55^th birthday.

What are the safe harbor guidelines for meeting the VEBA Classification and Benefits Test?

The 1999 IRS Internal Revenue Manual,⁴ provided safe harbor guidelines for employers. As a general matter, health benefits (non-income replacement benefits) satisfy the safe harbor only if they are offered to participants in equal amounts under equal terms, eligibility requirments, and conditions, without regard to salary level, position, or ownership interest in the employer. Income replacement benefits are discussed in the next question and answer. The Internal Revenue Manual contains other details and requirements for satisfying the safe harbor.

How are income replacement benefits, like life and disability benefits, affected by the safe harbor VEBA Benefits Test?

The law provides that income replacement benefits, like life and disability benefits, do not fail the VEBA Benefits Test merely because the benefits available bear a "uniform relationship" to compensation of those covered. The IRS Internal Revenue Manual safe harbor requirements specify that the benefit offered to each highly compensated individual cannot bear a larger ratio to the individual's compensation than the average benefit offered to lower paid employees bears to their average compensation. The Internal Revenue Manual contains other details and requirements for satisfying the safe harbor.⁵

¹All of the benefits funded under the Trust are insured. Compare Code Section 505(b)(3). If the medical, dental or vision benefits were self-insured, different rules would apply.
²This limit is subject to adjustment by the IRS for inflation using the same adjustment as the Code Section 401(a)(17) limit. The dollar limit for 2006 generally was $220,000.
³This limit (under Code Section 414(q)) is subject to adjustment by the IRS for inflation. The limit for the 2005 look-back year generally was $95,000 and $100,000 for 2006.
⁴Internal Revenue Manual Sec. 7.25.9.3.3.1 (Nondiscrimination Safe Harbor) and 7.25.9.3.4 (General Nondiscrimination Safe Harbor Requirements for Non-Income Replacement Benefits (2-09-1999).
⁵Internal Revenue Manual Sec. 7.25.9.3.4 (Income Replacement Benefits) (2-09-1999).