We describe HRAs and VEBAs in the same section because, as used in the public sector, both arrangements are HRAs and subject to rules that govern HRAs.  The IRS first approved HRAs in 2002.  Before they were approved, this writer was a relatively new lawyer (not yet a partner) and advised a local start-up that rollovers of unused amounts should be permitted under an HRA (it had a different name then), so long as employees were not allowed to contribute (that would result in an unlawful deferral of taxable income).  Our client started selling these plans around the country, and in a terrifying development, the IRS invited this writer to the Treasury Department in Washington D.C. to explain what was going on.  There was a lengthy discussion with a roomful of IRS and Treasury officials, including several who didn’t know how to use an inside voice, and yours truly was drenched with sweat.  But a month later, they issued Notice 2002-45 which authorized HRAs consistent with our product design.

Before HRAs were approved, we were also seeking a ruling on a separate track with the IRS to include an HRA within a Voluntary Employees Beneficiary Association (VEBA) trust.  VEBAs had been around forever and were commonly used to fund health plans, but recent tax law changes had doomed them to extinction in the private sector.  Because public employers are not subject to income tax, however, a public employer VEBA-HRA remained a viable option.  Shortly after the IRS issued Notice 2002-45, they issued a positive ruling on our VEBA application.

The Minnesota Service Cooperative VEBA Plan and Trust was the first of its kind.[1]  

VEBA-HRAs have not been widely adopted in the U.S. outside of Minnesota and the Pacific Northwest.  Consider yourself lucky if it’s in your benefit plan lineup (or could be).  Since the introduction of VEBAs, relatively few Minnesota public employers offer plain old HRAs, but we’ll still cover them.  By and large the rules are the same, except that employees in VEBA-HRAs can take their benefits into retirement and beyond.  Depending on the VEBA, you can even reimburse the medical expenses of your heirs after you die.[2]

[1] OK, a lot of people, including some lawyers and consultants from the East Coast, later claimed credit for inventing HRAs.  Some of us were working on the same thing.  But they weren’t associated with the only company that took them nationwide, the plan designs and theories varied, and they probably weren’t dragged to Washington DC to be yelled at.  It’s not like any of us invented penicillin so it’s all kind of silly.  But if they tell St. Peter at the Pearly Gates that they invented HRAs, it’s double hockey sticks for them.  Signed, a former hockey player.

[2] If you’re burning in a lake of fire and your granddaughter sends you a prayer of thanks for the liver transplant, you might find yourself with a perfectly cooked fish. 

An arrangement is not treated as an HRA if the arrangement interacts with a cafeteria plan in a way that permits employees to use salary reduction indirectly to fund the HRA.[1]  The IRS illustrates this rule with several examples: 

              Example 1:  An employer offers a health plan with a total premium cost, including the employee and employer’s share, of $5,000 for single coverage.  Employees may choose to reduce their salary by $2,500 or $3,500, payable monthly.  An employee who reduces their salary by $2,500 receives a contribution to an HRA of $1,000.  An employee who reduces their salary by $3,500 receives a contribution to an HRA of $2,000.   Because the HRA contribution is linked to the amount of salary reduction, the arrangement is not an HRA. 

              Example 2:  An employer offers a health plan with a total premium cost, including the employee and employer’s share, of $5,000 for single coverage.  The premium cost for single coverage is $2,000.   The employer contributes $2,000 to the HRA each year.  Employees have a choice either to use amounts in the HRA to pay their health insurance premiums or to pay their health insurance premiums through salary reduction under the cafeteria plan. Because an employee may use the reimbursement arrangement to pay a portion of the premium in lieu of electing to pay the premium through salary reduction, the reimbursement arrangement is indirectly funded through salary reduction. It is not an HRA.

These rules apply to VEBAs, of course, and you’ll see them reflected in model VEBA policies we’ll review later in this module.

[1] Notice 2002-45.