Is a VEBA Considered a Retirement Plan?

A Voluntary Employees’ Beneficiary Association, or VEBA, is a tax-exempt trust established by an employer to pre-fund specific welfare benefits, such as health and life insurance, for members, their dependents, and designated beneficiaries. A common misunderstanding is that a VEBA operates like a retirement savings plan. However, it is not a retirement income plan like a 401(k) or pension, as it cannot provide benefits similar to an annuity at retirement. While it can fund certain post-retirement medical benefits, its core purpose is centered on welfare benefits that safeguard health and protect against interruptions in earning power.

Permissible VEBA Benefits and Membership

Permissible VEBA offerings include payments for life, sick, accident, or other similar benefits intended to safeguard a member’s health or provide a buffer against a loss of earning power. These can encompass medical expense reimbursements, severance pay, supplemental unemployment benefits, and funds for continuing education. The structure of these benefits must be outlined in the plan documents, detailing the amount, duration, and eligibility requirements to ensure they are administered consistently.

The range of benefits can be tailored by the employer, from a comprehensive plan covering a wide array of medical expenses to more limited plans that may only cover dental and vision costs. Membership is restricted to employees who share an employment-related common bond. This bond can be formed by employees of a single employer, members of the same labor union, or employees of multiple employers in the same line of business and geographic area.

Internal Revenue Service (IRS) regulations require that at least 90% of the membership on at least one day of each quarter consists of employees. Membership must be voluntary, unless mandated by a collective bargaining agreement. The plan can also extend coverage to an employee’s dependents, beneficiaries, and retired or disabled former employees.

Contribution and Funding Rules

The primary source of funding for a VEBA is employer contributions, which are tax-deductible for the employer as a business expense under Internal Revenue Code Section 162. The deductibility of these contributions is subject to limitations designed to prevent employers from pre-funding benefits excessively. These rules are centered on qualified direct costs and additions to a qualified asset account.

Qualified direct costs refer to the amount an employer could have deducted if it had paid for the benefits directly, plus administrative costs. Additions to a qualified asset account are amounts set aside to pre-fund future liabilities for benefits like disability, medical, severance, or life insurance. The IRC imposes limits on how much can be added to this account each year, often based on actuarial calculations.

While employer funding is most common, employee contributions may also be permitted under the plan’s terms, typically made with after-tax dollars. The contribution framework is set by the plan itself, not by individual employee elections like a 401(k). The funds are held separately from the employer’s general assets and are protected from the employer’s creditors.

Tax Treatment for Employers and Employees

The VEBA trust itself is granted tax-exempt status, which means that investment earnings generated by the trust’s assets can accumulate without being subject to federal income tax. This tax-free growth allows the funds set aside for future benefits to grow more rapidly. However, if the trust generates income from an activity not substantially related to its exempt purpose, that income could be subject to the Unrelated Business Income Tax (UBIT).

For employees, contributions made by the employer into the VEBA on their behalf are not considered taxable income at that time, meaning the value is not added to their W-2 wages. The tax consequences arise when benefits are actually paid out from the trust to the employee.

The taxability of the distributed benefits depends on the type of benefit received. Reimbursements for qualified medical expenses, as defined under Internal Revenue Code Section 213, are received tax-free by the employee and can include payments for deductibles, copayments, and insurance premiums. In contrast, benefits that replace wages, such as severance pay or supplemental unemployment benefits, are treated as taxable income and are subject to income and payroll taxes.

Establishing a VEBA Trust

Creating a VEBA involves a formal process that begins with the establishment of a legal entity, most often a trust. The foundational step is creating a formal trust document that outlines the plan’s details, including the benefits offered, eligibility criteria, and membership rules. An independent trustee, such as a bank, is appointed to manage the trust’s assets in a fiduciary capacity.

A key part of the process is applying to the IRS for recognition of tax-exempt status under Internal Revenue Code Section 501(c)(9). This is done by filing Form 1024, Application for Recognition of Exemption. This application must be submitted within 27 months from the end of the month the trust was organized to ensure its tax-exempt status is retroactive.

To complete Form 1024, the organization must provide substantial documentation. This includes the signed trust instrument, a detailed description of the benefits to be provided, the classes of employees eligible to participate, and financial data.

Ongoing Administrative Duties

The trustee or plan administrator must manage the trust’s assets with fiduciary care, ensuring all actions are in the best interest of the plan participants. This includes prudently investing the funds and maintaining detailed records of all financial transactions, such as contributions, investment earnings, and benefit payments.

A primary annual requirement is filing informational returns with the IRS. Most VEBAs must file Form 990, Return of Organization Exempt From Income Tax, which provides transparency into the trust’s finances and is typically due by the 15th day of the 5th month after the plan’s year-end. If the VEBA has unrelated business income, it may also need to file Form 990-T.

Many VEBAs are also considered employee welfare benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA). If a VEBA is subject to ERISA and has 100 or more participants, it must also file Form 5500, Annual Return/Report of Employee Benefit Plan, with the Department of Labor. The plan must also continuously adhere to nondiscrimination rules, which prohibit favoring highly compensated individuals, to maintain its tax-favored status.