POPULARITY OF MEDICAL FLEXIBLE SPENDING ACCOUNTS TO RISE RAPIDLY

Within hours of the IRS releasing Revenue Ruling 2003-102 on September 3rd, Flex Corp notified all of its clients sponsoring medical flexible spending accounts ("FSAs") through their cafeteria plans about the new "Consumer Friendly" approach taken by the IRS allowing non-prescription over-the-counter (OTC) drugs and medicines purchased by employees to be reimbursed through the employer's medical FSA.  A great opportunity can now be offered employees to save additional federal, state and payroll taxes on items previously not covered under the FSA.  Whether or not an OTC item is reimbursable depends on whether it is for "medical care" or an item used for a person's "general health."

What OTC drugs/medicines are reimbursable?
While there is no approved "list" of OTC drugs and medicines which are reimbursable, generally, any medicine or drug purchased over the counter for medical care and purchased for use by an employee covered under the FSA, the employee's spouse, or dependents is reimbursable through the FSA.  Specific examples provided by the IRS are pain relievers, antacids, allergy medicines, and cold remedies taken to treat or cure an illness or injury.  Expenses reimbursable through the Plan for medical care would also include topical applications for burns, insect bites, athletes foot, etc.

When considering over-the-counter items and whether or not they qualify for reimbursement, a covered employee should determine whether the item being purchased qualifies as "medical care" as defined by the Internal Revenue Service.  This definition includes amounts paid for the diagnosis, cure, mitigation, treatment or prevention of a disease, or for the purpose of affecting any structure or function of the body.  Obviously a wide range of OTC items are covered in this definition.

Drugs such as Claritin previously requiring a prescription, which are now OTC and therefore no longer covered by insurance, can be purchased on a tax-free basis, greatly adding to the popularity of an Employer FSA.

What items are not covered?
If the OTC item is not for medical care but is merely beneficial for the general health of the individual, then the OTC item is not reimbursable.  Examples of non-reimbursable items include vitamins, dietary supplements, and personal hygiene items such as toothpaste and cosmetics. Distinguishing between items covered and not covered by the IRS guidance may pose a challenge in plan administration, but Flex Corp is assisting its clients in educating employees on the types of OTC items eligible for reimbursement.

Proper substantiation of OTC expense required.

In order to obtain reimbursement of OTC medical care expenses from the Plan, a covered employee will need to furnish a completed and signed request for reimbursement form (available from the Flex Corp web site at http://www.flexcorp125.com if you are using Flex Corp's services) along with a cash receipt providing the date of purchase, merchant name, the name of the item purchased and the cost of each item.

Implementing OTC Reimbursements

Most Flex Corp clients have already elected or are seriously considering expanding their FSAs for the 2004 Plan Year to include OTC drugs and medicines.  Now is an opportune time for employees to consider the added tax savings in running their OTC items through their FSAs as "open-enrollment" for the 2004 Plan Year approaches.  When added to other expenses already paid through the FSA (e.g.doctor's visit co-pays, insurance deductibles, and prescriptions drugs) significant tax savings are available to employees through the new "Consumer Friendly" approach the IRS has announced for OTC reimbursements.  Employees will also be able to overcome year-end "use it or lose it" fears when entering the FSA as more expenses are now eligible for reimbursement.

The three-year decline in the equity markets has resulted in many employers facing large increases in the contributions required to fund their defined benefit plans.  This funding burden caused by the interplay of loss in plan assets and declining interest rates may cause some plan sponsors to question the continued viability of traditional retirement plans.  With Hand and Associates providing actuarial valuation and consulting services for defined benefit plans throughout the country, we would like to remind plan sponsors of numerous positive aspects of defined benefit plans, many of which are not available through defined contribution plans (such as 401(k) savings plans).

Advantages to employees participating in defined benefit plans include:

• The employee knows in advance of retirement exactly what his monthly retirement income will be.  The amount of the benefit is usually based on factors such as age, earnings, and years of service at retirement.
  

• The employer, not the employee, is responsible for providing retirement benefits.  The benefits are not dependent on the employees' savings rate or fluctuations in the market.
  

• An employee can receive his monthly benefit for his lifetime as well as his spouse's lifetime.  There is no risk of outliving the annuity.
  

Employers experience positive aspects of defined benefit plans through:

• Retention and loyalty of valuable employees by providing a guaranteed benefit at retirement.
  

• Designing benefits to accomplish corporate goals, such as offering enhanced early retirement benefits.
  

• Providing significant retirement benefits for older employees with short periods of service who may recently have joined the Company.
  

• Years with favorable market performance can effectively permit an employer to offer retirement benefits at little or no cost, for that year.
  

If you would like more information concerning maximizing retirement benefits through a defined benefit plan, please contact Bryan Wilson at 1-800-444-1311 or by email.

Safe Harbor Plan Requirements

As a Plan Sponsor, you may find that your 401(k) Plan is constantly plagued with year-end return of salary reduction contributions and/or matching contributions to highly compensated employees (HCEs) courtesy of the "Average Deferral Percentage test and Average Contribution Percentage test ("ADP/ACP").  If your plan continuously has the "ADP" blues and everything has been done in an effort to increase participation among your non-highly compensated employees, you may want to consider whether satisfying the 401(k) "Safe Harbor" rules would be an attractive alternative.

How can a Plan Sponsor avoid 401(k) ADP/ADP testing each year and the cumbersome anxiety-filled return of salary reduction contributions to HCEs?  Here are the "trade offs" associated with gaining peace of mind and 401(k) safe-harbor status:

• Notice Requirement:  Each eligible employee must be notified before the plan year begins regarding the safe harbor nature of the plan and the employees' rights and obligations under the plan.
  

• Employer Contributions:  The Employer is required to make either a 3% of compensation contribution to all eligible employees or a matching contribution equal to 100% of salary deferrals up to 3% of compensation plus 50% match on contributions that exceed 3% up to 5% of compensation.
  

• Vesting and Distributions:  Employer Safe Harbor Contributions must be 100% vested and subject to the same limitations on distributions as applied to salary deferrals.
  

Some employers' plans already approach making monthly contributions which would satisfy safe harbor requirements, and with faster vesting schedules already mandated by the IRS for matching contributions, it may not be too much of a stretch for an Employer to consider the safe harbor rules for 2004 and be able to avoid the negative effect of having to return deferrals to HCEs each year.

For more information on 401(k) Safe-Harbor rules, please contact Steve Mueller at 1-800-444-1311 or by email.

Everywhere you look these days, you can see the results of innovative technology staring back at you.  And it did not take long to make inroads in Cafeteria Plan administration.  Debit cards are now the rage since the Internal Revenue Service's recently issued guidance regarding their use for the payment of eligible medical expenses in a flexible spending account or health reimbursement arrangement.

For each participant in the plan, the card is "loaded" with the annual elected benefit and the participant is free to use, or "swipe," the card at medical facilities to pay for eligible services including prescription drug co-pays, emergency room and doctor's office visit co-pays, dental procedures, vision expenses, etc.  The card can be used at any medical facility where MasterCard is accepted, and employees really do appreciate the card's convenience.

So, does the debit card eliminate the paperwork of filing claims?  No, in most cases it doesn't. The employee is still generally required to submit the paperwork for review.  The appeal of the card is that reimbursement is "up front," with no out-of-pocket expenditures for the employee. The paper claim submission is "after-the-fact" adjudication, as the IRS still requires that all claims be reviewed for eligibility.

If a participant uses the card to pay for items which are not eligible for reimbursement, the participant will be required to reimburse the plan for the non-covered items.  Failure to repay the plan can result in the forfeiture of card privileges for the participant, in which case claims will need to be submitted for reimbursement.  However, it has been found that employees don't wish to relinquish their debit card privileges, so repayment is generally not a problem.  The card is "blocked" when the employee terminates employment, so any claims submitted after the date of termination will be paper claims requesting reimbursement.

The employer will be required to pre-fund the plan for the debit card "swipes."  The pre-funded amount will be equal to fourteen (14) days of employees' combined health care reimbursement account contributions.  If funding falls below fourteen days of contributions, the employer will be notified, and will have twenty-four (24) hours to adequately replenish the account.  The employer is also ultimately responsible for ineligible purchases made with the debit card. Therefore, if all available resources are exhausted trying to recoup ineligible amounts from an employee, the employer will be responsible for funding that amount to the plan, and may then include that amount as taxable income on the employee's W-2 at the end of the tax year.

It is important to note that, while the card will also work for dependent care expenses, as well as parking and transportation expenses (offered under Code Section 132(f)), the IRS has not yet issued guidance regarding the use of debit cards for either of these benefits.  If you decide to permit payment of these types of expenses with the debit card, you should first seek legal counsel regarding the application of current IRS guidance to these types of benefits.

This article provides basic insight into debit card usage, its convenience and the responsibilities it creates. We believe that offering the convenience of the debit card to your employees will increase participation in your health care reimbursement plan, and it is certain to enhance your benefits package offering.

Cross-Testing or What Number Do You Need?

With the decline in popularity of defined benefit plans and the 401(k) plan arena still reeling from three years of below sea level investment returns, many employers are scrambling for alternative pension planning to supplement their current level of retirement savings, especially for highly compensated employees (HCEs).  With the onslaught of regulatory changes issued beginning at the end of 1994 and continuing even through today, we have seen some limitation increases which may help employers contribute additional amounts to their qualified plans. 

We have also seen the IRS loosen its grip somewhat in the nondiscrimination area, specifically, in cross-testing benefits and contributions.  Cross-testing allows an employer with a defined contribution plan to contribute different percentages or amounts for different employees within the same plan and convert these contribution rates to equivalent benefit rates at each employee's normal retirement age.  The general theory is that a cross-tested plan will be able to prove that each person, at his or her normal retirement age, will have an equivalent benefit rate which is nondiscriminatory, even though the contribution amount each year is not uniform for each employee.  Coming on the wings of the increase in defined contribution plan limits to the lesser of $40,000 or 100% of compensation, deductibility of employer contributions up to 25% of total covered compensation, and an increase in compensation limits to $200,000 used under a plan, there are now more ways to combat the dwindling retirement benefit pot.  One type of plan that can work well for employers with specific demographics is the cross-tested profit sharing plan.

Consider the following:  If an employer made a 5% profit sharing deposit each year on behalf of an employee age 50 and the same for an employee age 30 and they both made the same amount of salary, which one would have the largest retirement benefit at age 65?  This isn't a trick question.  With compound interest it is obvious that the 30 year old would have a significantly larger accumulation.  Expand the question:  If we converted the accumulated retirement dollars for each of the two employees into an annuity that paid a monthly lifetime income, what would be the percentage of income, each would receive?  Again this isn't a trick question.  The older employee would have a significantly smaller percentage of income provided by the amount accumulated at retirement than the younger employee.  It is this inequity that is addressed in the IRS nondiscrimination cross-testing rules.

There are a couple of hitches to using this type of arrangement.  First, the IRS has issued requirements that must be followed to even determine if a cross-tested plan will be allowed to be tested by converting the benefits payable at retirement; and, second, if a plan does make it past the first set of requirements, then the plan must be tested annually to assure that the contributions made are not discriminatory.  While these tests can be onerous, they don't have to be.

The first set of requirements that must be satisfied is for the cross-tested plan to either satisfy a minimum contribution gateway, provide "broadly available" allocation rates, or provide certain age-based allocation rates within specified parameters.

A plan satisfies the gateway if each non-highly compensated participant receives an allocation that is at least the lesser of 5% of compensation or 1/3 of the contribution allocation rate of the highly compensated employee who has the highest allocation rate.  If a plan uses the broadly available allocation rates or provides the age-based allocation rates, this minimum gateway need not be provided.  The broadly available allocation generally involves a demonstration which satisfies the minimum coverage rules by each different tier of allocation rates.  Similarly, the age-based allocation rates can be demonstrated to satisfy the requirements for having a cross-tested plan by demonstrating that the allocation rate schedule is available to all employees and increases gradually at regular intervals.

The second tier of requirements is to pass nondiscriminatory testing under 401(a)(4) of the Code by proving that the contributions, when converted to benefits, do not discriminate in favor of highly compensated employees.  This is known as "cross-testing."  Under a cross-tested defined contribution plan, the theory is that, for those who are older, with fewer years to retirement, larger contributions can be made on their behalf in order for them to have the same benefit as a younger employee who will have more years to reach normal retirement.

There are several types of cross-tested defined contribution plans that are increasing in popularity today:  "age-weighted" profit sharing plans and "new comparability" profit sharing plans.

Under the age-weighted profit sharing plan, the allowable allocations are determined by the ages of the participants.  In a straight age-weighted profit sharing plan, the older the participant, the larger the allocation as a percentage of pay.  This is similar to a defined benefit plan because both of these plans will simply benefit older participants more than younger ones. That can be a drawback to this type of plan.  There is no flexibility.  Older ages equal larger contributions.  If a firm has some older non-key employees, it can be viewed as "unfair" since age alone dictates who gets a larger contribution.

The "fairness" of the plan is solved by "new comparability," since it can be structured to contribute the same percentage of pay for all non-key employees.  Therefore, the contribution level for each participant is not dependent entirely on age as in an age-weighted plan.

New comparability profit sharing plans offer increased flexibility.  Employees may be divided into separate groups and each group can receive a different contribution percentage.  Groups can be divided in accordance with salary levels, job classifications, length of employment, or any combinations of any of these classes of employees.

In an age-weighted plan, the projected benefits at retirement for all employees must be the same.  In a new comparability plan, the average projected benefits for the non-highly compensated employees must be at least 70 percent of the average projected benefits of the highly compensated employees.

The cross-tested type of plan will appeal to small businesses where the owner is older than most of the other employees.  The degree to which these designs create appeal to the owner can only be decided by testing each individual situation since it will vary by the groupings and ages of the employees in each business.

Small business owners owe it to themselves to explore the potential opportunities these new cross-tested profit sharing plans have as an optional method of providing retirement benefits. Retirement savings, tax deductions, great flexibility, and a larger share for the owner may now be possible with these new plans.

If you would like to explore how "cross-testing" might benefit your organization, please contact Carla Winters at 1-800-444-1311 or by email.

For over 60 years, employers have relied on Hand Benefits & Trust, Inc. as a single-source provider for professional expertise in the design, administration, and trusteeing of their employee benefit plans, including:

	Actuarial Valuation/Administration of Defined Benefit Retirement Plans
	401(k) - Daily Valued/Participant Directed Savings Plans
	ESOPs, Target Benefit, Cash Balance Plans
	Benefit Plan Trust Services
	Governmental/Tax Exempt Entity 403(b) and 457 Plans
	Cafeteria Plans with Medical and Dependent Care Reimbursement Accounts/HRAs, HSAs, and Debit Card Technology
	WEB/VRU Benefit Information Access
	Qualified Transportation Plans

For more information on the services provided by Hand, please contact Steve Mueller at 1-800-444-1311 or by email.

Hand Benefits & Trust, Inc.
5700 Northwest Central Drive, Suite 400
Houston, Texas  77092-2092