EMPLOYEE BENEFITS
Vacation/Sick Day Conversion Plans: A Partial Solution to Rising Health Care Costs
May 2003
By Donald R. Saxon*
This article highlights a longer article by Donald R. Saxon entitled Converting Unused Vacation Days to Retiree Medical Benefits: A Proposed Partial Solution to an Emerging National Crisis, appearing in the June 2003 edition of Employee Benefits Journal. Download the entire article.
Healthcare costs and availability is a problem for most Americans and an acute problem for retirees. Some of the largest cost increases have occurred in the area of prescription drugs which has its greatest affect upon the retiree population attempting to face increasing costs on a fixed income. For those employers who, as a result of union contracts or good corporate citizenship, provide retiree medical benefits, the escalating cost of those benefits has become a bigger slice of the healthcare pie, increasing the industry burden: 44% of the beneficiaries of the Big 3 auto health plans are retirees, healthcare costs account for $1,234 of the cost of a vehicle produced by General Motors. Bethlehem Steel provides healthcare benefits for 130,000 beneficiaries, 90,000 of whom are retirees. U.S. Steel’s estimated expenses to provide pension and health benefits to its quarter of a million retirees and their survivors is $12 billion. These costs for retiree benefits, euphemistically entitled “legacy costs”, substantially increase the cost of goods sold for American companies and inhibit the ability of those companies to enter partnerships and acquisition arrangements which might make these companies more competitive in the world marketplace. The benefits are lost if the company goes bankrupt.
A number of employers are terminating their retiree medical benefit as such benefits become increasingly expensive and the cost of future retiree benefits is difficult to predict. However, retirees and industry would be better served if we can develop a source to assist retirees in meeting medical costs while not increasing the industry burden.
A Potential Source
There is a source of potential funding which, if properly structured, could fund a significant portion of retiree medical costs without significant costs to either employers or employees: According to the Bureau of Labor Statistics, 49% of all vacation days and a large number of sick days are forfeited each year. These are not days which are paid for in cash or allowed to be carried over to future years. Almost half of all vacation and sick days are forfeited without corresponding compensation.
Proposed New Employee Benefit Plan
We propose the establishment of a new employee benefit program wherein each year’s unused vacation days and sick days which an employee would otherwise lose, receive in cash or defer to another year, are transferred into that employee’s account in a Voluntary Employee Benefit Association (VEBA) trust. The amounts contributed are non-forfeitable, tax-deductible to the employer, non-taxable to the employee and not subject to payroll taxes. The earnings on the employee’s VEBA account grow tax-free. Distributions from the account to pay retiree medical benefits for the employee/dependents are non-taxable to the employee.
The plan would be defined contribution in character. That is, a retired employee will use his/her VEBA account balance to purchase benefits from a number of available options. The employer has no payment obligations and no legacy responsibilities. The funds from contributions and earnings in the VEBA account comprise the entire employee entitlement. The employer has no funding obligations.
Plan Structure
The proposed plan requires employer establishment of a welfare benefits VEBA trust and complementary corporate vacation/sick day policy as follows:
1. The company adopts a vacation policy requiring all employees to take a two-week vacation. However, any vacation time in excess of two weeks may either be taken as vacation days or contributed to the company sponsored VEBA.
2. The company adopts a sick leave policy that the cash value of any unused sick days at the end of the calendar year are funded into an employee’s VEBA account.
3. The VEBA would be a qualified tax-exempt IRC 501(c)(9) trust subject to ERISA reporting and disclosure requirements. Each participating employee will have a separate account within the VEBA into which the cash value of sick days and vacation days are contributed. The account is portable, non-forfeitable, and may be taken with the employee when he moves to other employment.
4. The employee’s VEBA account may be used solely to fund retirement medical benefits. Benefits of retirement could include a pre-Medicare-eligible health plan, payment of COBRA premiums, a prescription drug benefit plan, a Medicare supplemental, Medi-gap insurance plan or direct payment of Medicare premiums. The VEBA could also offer benefits in the form of direct medical reimbursement if the plan met the non-discrimination tests of IRC §105(h).
5. Upon the employee’s death, healthcare benefits could continue for the employee’s spouse and other dependents until the VEBA account was exhausted. Any cash distributions to employees/dependents would be subject to taxation.
Example
The Acme Widget Company of Erehwon, New Hampshire (“Acme”) establishes a VEBA and vacation policy allowing individuals to contribute any unused vacation days in excess of two weeks to the employee’s VEBA account. In addition, the employee rates five sick days per year; any sick days not used would be automatically contributed to the employee’s VEBA account.
1. Jane. Jane Schmukatella, age 45, elects for funds representing five days of vacation to be funded into her VEBA account as well as two sick days per year. Jane earns $100 per day. Assuming Jane worked for 20 years and retired at age 65 (also assuming a 5% growth rate) the funds available at retirement to purchase medical benefits would be $26,161. The funds could be used to purchase a Medicomp Plan for Jane at $262.32 per month which would last 10.8 years. Jane will not be taxable upon the distributions from the VEBA to pay for these medical benefits.
2. Horace. Jane’s cousin, Horace, begins making contributions at age 35 but is only able to contribute three days worth of vacation and two sick days per year for a total annual deferral of $500. After 10 years he is promoted and earns $150 per day for a total annual deferral of $750. He continues to defer the same number of vacation and sick days at the increased rate of pay for another 15 years; a total of 25 years of deferrals.
Horace takes early retirement at age 60; he is not disabled. Horace would have $32,450 available to pay for COBRA continuation benefits for 18 months; the remaining balance could be applied towards the purchase of an individual policy until he reaches age 65 and became eligible for Medicare. Alternatively, if Horace continued to participate in the plan as a member of the retiree group until age 65, the premium for Horace and his wife would be $631. The funds in his VEBA account would cover the premiums for Horace until he reached age 65 and became eligible for Medicare.
If Horace is covered by his wife, Petunia’s, medical plan when he retires, so he does not begin withdrawing until age 65, the funds then available, $41,371, would cover Medicare payments for Medicomp payments and a dental policy for Horace and Petunia for almost 10 years.
Benefit to Employers
The plan actually saves the employer money. While cash paid in lieu of vacation or sick days are wages subject to payroll taxes, contributions to and payments by a VEBA for life, sick and accidental benefits are exempt from payroll taxes. The employer would therefore save the employer’s portions of payroll taxes. With a large company, those savings will easily exceed the cost of implementing the plan and will reduce the employer’s overall payroll costs. Vacation/sick day conversion plans are a win/win opportunity and should be considered by any employer.
Download the full version of this article.
*Donald R. Saxon is admitted in New Hampshire, California, and Nevada.
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