President Bush signed the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) into law on June 17, 2008. The HEART Act permits, and in some cases requires, plans to provide enhanced benefits for military personnel. The HEART Act also extends parity of mental health benefits in group health plans and changes rules relating to withholding requirements for expatriates.
No Penalty for Early Withdrawal from 401(k), 403(b) or 457(b) Plans
The new law makes permanent the exemption from the 10% early withdrawal penalty for withdrawals by reservists called to active duty for at least 180 days. A reservist is also permitted to recontribute the amount withdrawn to an individual retirement account within two years of the last day of active service.
Qualified Plan Death Benefits
Effective as of January 1, 2007, in the case of death during qualified military service, an employee must be treated as if he or she had died while actively employed (but not for purposes of benefit accruals). Many plans provide for accelerated vesting or ancillary death benefits upon death during active employment. As a result, plan administrators need to determine if this new requirement will retroactively vest any survivor benefits. This requirement applies to qualified plans, 403(b) plans and governmental 457(b) plans.
The HEART Act also permits, but does not require, plans to treat a participant who dies or becomes disabled while performing qualified military service to be treated as if the participant had resumed employment. This will result in participants’ being credited with their time in military service for benefit accrual purposes. In addition, the HEART Act permits the employer to make up any employee contributions missed by such participants based on the participants’ actual contributions during the 12-month period immediately preceding the qualified military service. If an employer provides for additional accruals or contributions, all qualifying participants must be treated on a reasonably equivalent basis. An employer may elect to apply this provision as early as January 1, 2007.
Treatment of Differential Pay
Effective January 1, 2009, differential wage payments made to military personnel must be treated as W-2 wages (previously, these amounts were reported on Form 1099). As such, these payments are subject to federal income tax withholding and must be treated as compensation for determining contributions and benefits under the employer’s retirement plans.
The HEART Act provides that an individual in qualified military service for more than 30 days and receiving differential pay must be treated as having a severance from employment, and therefore eligible to receive a distribution of elective deferrals. However, if the individual takes a distribution, he/she will be barred from making elective deferrals or employee contributions for six months. This provision is effective for plan years beginning after December 31, 2008.
Health Flexible Spending Account (FSA) Payouts
The HEART Act allows a healthcare fl exible spending account to permit reservists called to active duty for 180 days or more to withdraw all or a portion of any unused money (notwithstanding the normal “use it or lose it” rule). The distribution of these funds must be made during the period from the date of call-up until the last day the benefits could normally be reimbursed for the plan year. Although the HEART Act does not address the issue, it would appear that this distribution would be taxable. The provision is optional and may be applied to distributions after June 17, 2008.
Any plan amendments required to refl ect these new rules must be adopted by the end of the 2010 plan year.
The HEART Act requires 30% withholding on distributions of eligible deferred compensation for U.S. citizens who relinquish their citizenship and long-term residents who terminate their residency on or after June 17, 2008. This applies to qualified plans, 403(b) plans, 457(b) plans, interests in a foreign pension plan, deferred compensation and payments received in connection with performing services to the extent not included in income under Section 83. Certain accounts, including health savings accounts, IRAs and Section 529 accounts, must be treated as having been distributed the day before the expatriation date.
Extension of Mental Health Benefits
The HEART Act also extends the current mental health parity rules for group health plans through 2008 while Congress continues to consider other legislation that would make the parity rules permanent.