In addition to providing certain military benefits, the recently enacted Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART) includes required and optional changes in benefit plans.
Survivor Benefits – Required Plan Provision. Under HEART, qualified retirement plans, such as 401(k), profit sharing, money purchase, defined benefit and cash balance plans, are required to treat a participant who dies while performing qualified military services as if the participant resumed employment and then died while employed, for all purposes other than increased benefits. This means that the participant’s survivors will be entitled to death benefits under the plan. For a 401(k), profit sharing or other defined contribution plan, this typically means that the participant would become 100% vested in the participant’s plan benefit if the plan otherwise provides for 100% vesting if the participant dies while employed. For a defined benefit plan, including a cash balance plan, this may mean that a pre-retirement death benefit is available to the survivors. This new provision applies to deaths occurring on or after January 1, 2007, although plan documents do not need to be amended until the last day of the first plan year beginning on or after January 1, 2010 (December 31, 2010, for a calendar year plan). The employer is not required to provide increased benefits for the deceased participant, although the employer may do so as described in the next bullet point.
Disability and Survivor Benefits – Optional Plan Provision. An employer is permitted to treat an employee who is on military leave and dies or becomes disabled as having returned to service immediately before the death or the disability, and eligible for benefit accruals (employer contributions or additional years of benefit service under a qualified retirement plan), under a tax-qualified retirement plan during the period of military leave. An employer wishing to provide this benefit must amend the plan to include the benefit. If offered to any participant, the benefit must be available to all participants who die or become disabled during military service on a reasonably equivalent basis under all plans sponsored by the controlled group.
Differential Pay – Required Plan Provision. Although employers are not required to provide differential pay (pay equal to the difference between the employee’s salary from the employer and the employee’s military pay) to employees for their military service, some employers choose to support their soldiers by providing that benefit. The IRS has in the past treated differential pay as income other than wages since the employee was no longer actively working for the employer. Under HEART, that differential pay will be considered wages and subject to wage withholding effective after December 31, 2008. For plan years beginning on or after December 31, 2008, differential pay will also have to be taken into account under the employer’s qualified retirement plan. An employer providing differential pay that is considered compensation under a plan must provide such pay on a reasonably equivalent basis to all employees within the controlled group who are performing uniformed services.
Distributions of Elective Deferrals – Required Plan Provision. Ordinarily, a 401(k) plan participant must have severed from employment (or died, became disabled, attained age 59½ or incurred a hardship) in order to receive a distribution of elective deferrals from the plan. Effective for plan years beginning after December 31, 2008, plan participants on active military leave for at least 30 days are treated as having severed employment and therefore eligible for a distribution of elective deferrals. However, the plan must preclude a participant who has received such a distribution from contributing elective deferrals to the plan for six months after the distribution date.
10% Penalty Tax Exception Made Permanent. The Pension Protection Act of 2006 added a temporary exception to the 10% penalty tax usually imposed on premature distributions from qualified retirement plans and IRAs for “qualified reservist distributions.” These are distributions that meet certain criteria but are generally made after a member of the military has been called up for active duty. HEART makes that exception to the 10% penalty tax permanent.
Distributions from Health FSAs – Optional Plan Provision. HEART allows employees on military leave to receive a distribution from a medical flexible spending account (FSA) under a cafeteria plan without having to incur medical expenses. This provision is effective benefitsfor distributions made after June 17, 2008, the enactment date. An employer wishing to allow this distribution should amend its plan to add the provision. The employee must be called to active duty for a period of at least 180 days and the distribution must be made during the period beginning with the call to active duty and ending on the last day that reimbursement would otherwise be made for the plan year that includes the call to duty. It is not clear whether the employee is limited to the positive balance in the account at the time of the distribution, determined on a cash basis, or whether the employee can claim the full amount of the FSA election, reduced by prior paid claims under the normal uniform coverage rules. Presumably, the distribution will be taxable although it is not clear whether wage withholding will be required.