An Overview of Employee Benefits in US

Chetan Jain
 FOREWORD

This document has been prepared to give an overview of Employee Benefits

in US. This is a comprehensive document, which can provide all
HRMS/Payroll consultants with a lucid functional understanding of the
various components of Compensation & Benefits in US.

Any ideas/suggestions/comments are welcome.

Thanks

Chetan Jain

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Table of Contents

Contents Page No.

Title Page.......................................................................................................01

Foreword…………………………………………………………………….02

This Page........................................................................................................03

Introduction ...................................................................................................04

Mandated Benefits.........................................................................................08

Health Insurance............................................................................................26

Life Insurance................................................................................................32

Cafeteria Plans...............................................................................................41

401 k Plans.....................................................................................................44

Fringe Benefits & Executive Perks................................................................51

Employee Termination...................................................................................56

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Introduction

Employee Benefits form a significant part of over all compensation in US. On average, employers
spend about 20% to 33 % of payroll on employee benefits. The full range of benefit programs
includes benefits that are required by law, such as Social Security and workers' compensation, as
well as voluntary benefits—time-off benefits, such as leaves of absence, vacation and holiday
pay; retirement benefits; health and related insurance benefits, and a variety of other
miscellaneous benefits commonly provided by employers, including tuition assistance plans,
referral bonus plans, adoption assistance plans, and club memberships.

The most common types of benefits in US include:

 Group Medical Insurance;

 Group Dental Insurance;
 Group Life Insurance;
 Disability Insurance;
 Defined Contribution or 401(k) Plans;
 Defined Benefit Pension Plans; and
 Cafeteria (or Flex) Plans.

Eligibility Criterion for Employee Benefits:

As per the law, all employees are not entitled to receive employee benefits. Like for example,
Independent contractors, who are not employees are not entitled to receive benefits, (unless the
employer treats them as such—in the eyes of the law). If the government (usually in the form of
the Internal Revenue Service and/or the Department of Labor, Wage and Hour Division) can
prove that the independent contractor is, in fact, an employee, then the employer will be required
to provide the same level of benefits that it provides to other employees—and subject to interest
and penalties, as well.

Benefits Required by Law

As required by Federal and State Laws, the following are the statutory benefits as applicable in
the US:

Social Security and Medicare;

Workers' compensation;
Short-term disability (in certain states);
Unemployment compensation;
Time off to vote;
Time off to serve as a juror if summoned by a court;
Time off for military duty;
Time off for family and medical leave purposes;
Accommodation of religious observance

Voluntary Benefits

Many employers voluntarily provide employees with additional fringe benefits, that are not
required by law. These include:

Paid time off for vacations

Sick days and holidays,
Free parking

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Many employers find that such benefits can enhance the total compensation package, while
helping to balance its employees' work-life requirements. Many of these initiatives help ensure
that workers are more rested and relaxed—and therefore more productive. Employers also
provide paid leave and similar benefits to help them attract and retain qualified workers with
benefits that are comparable to those offered by other companies. Such benefits can often be
more cost-effective than simply offering additional salary.

Medical and Life Insurance Programs

One of the most popular employee benefits is health insurance. Along with salary and pension
benefits, medical coverage is often one of the main factors that influence an individual's decision
to accept an employment offer. It is also one of the most costly benefits for employers to provide.

The principal types of insurance programs offered by employers are:

Basic health insurance (basic medical surgical/hospitalization),

Major medical insurance
Term life insurance / Whole life insurance.
Dental and vision plans.

In response to employers' cost-control needs, insurance providers continue to offer new group
health and major medical insurance products. Health Maintenance Organizations (HMOs),
preferred provider organizations (PPOs) and other managed-care services are several ways to
offer employees comprehensive medical coverage, while keeping a lid on costs.

Cafeteria Plans

In order to allow employees to purchase the benefits that they most value, many employers
establish flexible benefit or cafeteria plans. With a cafeteria plan, employees are allocated an
"allowance"—a specific amount of premium payments—for the purchase of benefits and an array
of benefit options from which to choose. Some of these programs are also called "voucher" plans.
The increased flexibility afforded both employers and employees, has dramatic potential for
tailoring compensation packages to attract and retain employees in vastly different life
circumstances. It also helps employers avoid wasteful expenditures.

Employee Welfare Benefit Plans

Cafeteria plans generally offer any or all of the following to plan participants or their beneficiaries:
Medical, surgical, or hospital care, Accident, disability, or death benefits, Vacation and sick leave
benefits, Severance pay, Apprenticeship or training programs, Day care, Scholarships and
tuition reimbursement, Prepaid legal services.

Retirement and Deferred Compensation Plans

Retirement and deferred compensation plans rank among the most important benefits to most
employees- Pension and profit sharing plans are probably the most popular retirement plans, and
are often encountered as part of a union's collective bargaining package.

401(k) plans have been gaining popularity of late, especially since 1986, when the tax laws
severely curtailed the benefits of IRAs. Pension plans place their emphasis on providing benefits
after retirement—rather than current salary—based on some form of income payable periodically.
Pension plans may also provide ancillary benefits payable upon death, disability, or other
termination of employment (apart from retirement). Employers fund most pension plans but some,
such as 401(k) plans, also include employee contributions. Pension plans and most other "tax
qualified" deferred compensation arrangements are subject to complex rules under the Employee

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Retirement Income Security Act (ERISA). ERISA applies to all employers engaged in commerce,
with the exception of churches and federal, state, and local government employers. The
Department of Labor (DOL) enforces ERISA.

Employee Stock Ownership Plans

Companies that issue stock may set aside stock for employees instead of cash. These employee
stock ownership plans (ESOPs), give employees a share in the profits they help to create, thus
giving them incentive to work hard. Various wage/salary and stock compensation packages are
available. ESOPs, Incentive Stock Options (ISOs) and other compensation plans that are tied to
company stock have gained much popularity in recent years, especially with growing companies.
These plans, however, are subject to various rules and regulations.

Reimbursement Programs

Employers may offer a variety of expense reimbursement programs. One popular expense that is
often reimbursed is the moving expense. Many employers reimburse employees who are
required to relocate in the course of their employment. Some employers also reimburse newly-
hired employees for the costs of relocation, depending on their job level and the arrangements
negotiated between the company and employee. Even if the employer does not reimburse the
employee for expenses incurred in such a move, the employee may be allowed a moving
expense deduction for tax purposes.

Termination, Death or Retirement

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) is the federal medical
continuation statute. Under COBRA, employees and their eligible dependents who are covered
under an employer's group health insurance plan must be given the opportunity to elect to
continue as members of this plan (at their own expense) for certain time periods, if coverage is
lost as a result of the occurrence of a "qualifying event."

Reporting and Disclosure Requirements

Depending on the particular benefit plan, there is an array of documentation that may be required
to be supplied to active plan participants, former employees, beneficiaries, and various
government agencies.

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Mandated Benefits:

Introduction

In addition to the fringe benefits that many employers provide voluntarily, various state and
federal laws require that certain minimum benefits be provided to employees. These mandated
benefits include contributions to the federally funded programs, such as Social Security and
Medicare, as well as state-mandated worker’s compensation and disability insurance. These
benefits—which most employers must provide—are discussed in this section.

Social Security & Medicare

Social Security pays benefits when employees retire, become disabled, or die. They must meet
certain eligibility requirements for each type of benefit. Other members employees family may
also be eligible for benefits.

Who Is Covered?

Practically everyone who is employed or self-employed is covered by Social Security and

Medicare. The exceptions include the following:

Most federal government employees hired before 1984: These employees are covered by
Medicare, but ordinarily not by Old Age, Survivors and Disability Insurance (OASDI)—Social
Security. Rather, Civil Service Retirement or a similar pension plan covers them. Railroad workers
are covered under the separate, federally administered Railroad Retirement system. Workers
with coverage under Railroad Retirement and Social Security have coordinated benefits. Some
state and local government employees (roughly 25%). Each state and local government unit that
has a pension plan formerly decided for itself whether to join Social Security; most have joined.
Once elected, participation could not be discontinued. After June 1991, Social Security and
Medicare covered all state and local units with no pension plan. Medicare covers all state and
local government employees hired after March 1986, even if not by Social Security.

Who Pays?

The employer and employee pay taxes for Social Security and Medicare. The employer pays half
the cost—while the employee receives all the benefits.

What Does it Cost?

The taxes that employee and his employer pay each year are based on the tax rate (percent of
pay) and the amount of earnings. Federal law establishes tax rates. The maximum taxable
amounts increases each year, based on increases in the average wages and salaries of all the
employees in the country.

Payroll Taxes

Old Age, Survivors and Disability Insurance (OASDI). This tax pays for cash benefits to entitled
beneficiaries. Hospital Insurance (HI). This tax pays for hospital benefits for people covered by
Medicare.

Payroll taxes paid by employees are not deductible on individual federal income tax returns, or
most state income tax returns.

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All salaries, wages, bonuses, and commissions that one receives for working are taxed and
credited to employees’ earnings record. The payroll taxes are withheld from every paycheck until
the Maximum Taxable amount for the year is reached.

In addition to cash payments, taxable amounts include the value of clothing, meals, and lodging,
except meals and lodging provided for the convenience for your employer. The first six months of
sick pay are taxed. The value of employer-provided life insurance exceeding $50,000 is also
taxed.

Unemployment Insurance

Unemployment compensation provides for a continuation of income for unemployed workers and
their families. Employers do not have a choice of whether to provide unemployment benefits; all
employers must contribute to the unemployment insurance funds in their states. And, law sets the
amount of benefits.

Benefits are available only to workers who are actively seeking suitable work to replace jobs they
lost through no fault of their own. Workers laid off when there is no longer a need for their
services and workers who lose their job because of lack of ability to meet the job’s requirements
are eligible for benefits. However, claimants who are fired because of misconduct or who are not
willing, able, and available for work are not eligible for unemployment benefits.

Employer’s Obligation to Participate

Employers are required by federal and state law to make unemployment insurance contributions
on behalf of their employees. Under federal law, an employer need only have employed one
employee for part of a day in each of twenty days in the current or preceding calendar year to be
obligated to provide unemployment insurance for all employees. Federal unemployment laws
nonetheless cover even employers that do not meet this twenty-day test if they have paid at least
$1,500 in wages during a calendar quarter in the current or preceding calendar year.

Workers Not Covered

Not all workers are considered employees for unemployment tax purposes. Unemployment tax
laws do generally not cover the following workers:

A partner or sole proprietor of a business;

A sole proprietor’s child under age 21, spouse, or parent (usually including, step-,
Foster, and adoptive relatives);
Members of the board of directors;
Independent contractors;
Full-time college students under age 22 who are enrolled in work-study programs;
Student nurses or interns;
Students who work for the schools in which are enrolled; and
Life insurance sales representatives paid solely on commission.

Payment of Federal Tax

Employers must deposit each quarter’s Federal Unemployment Tax Act (FUTA) payment by the
last day of the calendar month following the end of the quarter (e.g. April 30, July 31, October 31,
and January 31) but may have ten extra days to file if all taxes were paid when due. For the first
three quarters, no deposit is necessary if the undeposited tax due for the current and prior
quarters totals less than $100. For the last quarter, the balance due can be included with the
return if the tax (deposited or undeposited) for the entire year totals less than $100.

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Employers must file Form 940, Employer’s Annual Federal Unemployment Tax Return, by
February 10 (if taxes were not deposited in a timely fashion by January 31).

Unemployment Insurance Administration

Unemployment insurance is administered through a joint Federal-state program. Claims for

benefits are presented by out-of-work claimants to offices run by the state.

Responding to Claims

After a claimant files for benefits, the state board contacts the claimant’s last employer to obtain
the facts about his or her separation from employment. Because the majority of states allow
employers only seven to ten days to respond, it is important to respond quickly. If the employer
chooses not to contest the claim, perhaps because of a termination agreement with the
employee, the common practice is simply not to respond. The state board then issues an initial
determination of eligibility.

Appeals

Both the employer and the claimant have the right to demand a hearing if they are not satisfied
with the initial determination. The easiest way to lose an appeal is to fail to appear at the hearing.
Although either party may appeal the hearing decision further, only documentation submitted
during or before the hearing will be reviewed on further appeal. Although benefits may be paid
during the appeals process, the employer is entitled to have its account reimbursed by the state
insurance board if the claimant is
ultimately ruled to have been ineligible.

Eligibility For Benefits

Generally, to be eligible for benefits, claimants must have lost their job—whether permanently or
temporarily—through no fault of their own, and must still be out of work. They must be ready,
willing and able to accept other similar work.

Eligibility criteria vary significantly from state to state. Employers need to become familiar with the
criteria in the states in which they do business to assess how terminations will affect their
experience ratings and to challenge improper claims.

Minimum Work History

Most states require that claimants meet minimum earnings requirements to qualify for benefits.
The requirements are sufficiently modest to enable most part-time workers to qualify.

Involuntary Nature of Job Loss

Employees who quit without good cause are not eligible for unemployment benefits. Depending
on the facts and circumstances and on state law, employees who quit because of harassment,
unfair demotion, dangerous work conditions, changes in job duties, or the need to follow a spouse
who has been relocated may be deemed to have good reason to quit and therefore become
eligible for benefits.

Failure to show up for work for three consecutive days without an explanation is usually treated
as a resignation.

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Employees who are fired due to lack of work are eligible for benefits. However, employees
dismissed for job-related misconduct are normally ineligible, provided the state unemployment
insurance board agrees that the employee’s action or inaction constitutes misconduct.

The employer should be prepared to show that the employee knew the misconduct was
prohibited and was discharged because of it. Employees who lack the ability to perform duties of
their job to the employer’s satisfaction are normally eligible for benefits, provided they are seeking
other work that they are able to perform. A claimant who is unable to perform any work because
of a disability is not eligible for unemployment benefits, but may be entitled to disability benefits.

Actively Seeking Suitable Employment

To qualify for benefits, claimants must be ready, willing and able to work. Most states require
claimants to report regularly (usually weekly) on the progress of their job search activities.
Claimants who turn down “suitable” employment without good reason are disqualified, as are
claimants who fail to continue seeking suitable employment.

The definition of suitable employment is often subject to controversy. It may refer to the claimant’s
customary work or to work for which the claimant is suited by training and experience.

The definition of availability for work is another concern. Full-time students normally are not
eligible for benefits, but attendance in a training program may be acceptable if the training (or
retraining) program is approved by the state unemployment compensation board.

Establishing Unemployment

A claimant must not only be unemployed to receive benefits but must also exhaust any
severance, vacation, or holiday pay, and then go through a brief waiting period.

Short-Term Compensation

Several states allow employees whose hours are reduced under a work-sharing plan to collect
unemployment benefits on a prorated basis. This arrangement allows employers to spread the
impact of a slow-down more evenly throughout the work force and to keep trained workers on the
payroll. Employers need to work out a plan and obtain the approval of the state and any unions
that are affected. These employers may also be required to pay a higher tax rate.

States With Short-Term Compensation Laws

The following states have short-term compensation laws: Arizona, Arkansas, California, Florida,
Louisiana, Maryland, New York, Oregon, Texas, Vermont and Washington. In addition, Illinois has
an unusual short-term compensation law that is actually unrelated to the unemployment
insurance system and that requires the employer to repay the state dollar for dollar.

Short-Term Compensation Provisions

Typical short-term compensation provisions under state laws include the following:

Each employer’s plan requires state approval. If employees have a union contract, the union
must approve the plan, in writing. The proposed reduction in hours for affected employees must
be between 10 percent and 40 percent. (At least one state ignores reductions of less than 20
percent, and another allows reductions of up to 50 percent.) Some laws specify that wages must
also be reduced by a minimum amount. A minimum number or percentage of employees must be
affected - typically, at least 10 percent. But, Arizona and Oregon merely require that two or three
employees be affected Employees must meet certain coverage requirements that apply to regular
unemployment insurance benefits, such as work history and waiting period. The benefit amount

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is typically the regular unemployment benefit times the percentage reduction in hours or in pay.
The maximum duration of benefits is twenty-six weeks per year. The employer may have to pay
a higher tax, either in the form of a higher experience rating or, for employers already paying the
maximum tax, in the form of a surcharge.

Tax Considerations

Federal and state unemployment taxes are fully deductible by employers. In contrast, recipients
of unemployment insurance benefits must pay federal income tax on the full amount of
their benefits. Although a few states still follow the old federal formula, which provided for a
partial exclusion of unemployment insurance benefits from taxable income, most states now tax
unemployment compensation in the same way as regular wages.

Sick Pay Plans

Sick leave pay generally provides employees with full pay for occasional unplanned absences
caused by non-work related personal illness or injury. Although most employers are not required
by law to provide paid sick leave, most employers do allow some paid time off to employees who
are unable to work because they are sick or injured. Sick leave allowances may be capped by a
formal policy at a fixed number of days per year, or they may be discretionary.

Medical leave and disability.

Medical leaves of absence often referred to as disability leaves, are generally longer leaves,
during which the employer does not continue to pay salary but does hold the employee’s job.

Most employers with fifty or more employees are now required by the Family and Medical Leave
Act of 1993 to grant unpaid medical/disability leaves of up to twelve weeks per year for eligible
employees. Employers must continue health benefits during this leave and, with some
exceptions, must restore the returning employee to the same, or an equivalent, job.

Paid Sick Leave

Paid sick leave is a common benefit, enjoyed by about two thirds of the employee population.

Generally, in companies providing this benefit, all full-time regular employees are eligible for sick
leave at full pay. In some cases, sick leave is granted to part-time employees on a prorated
basis.

Types of Sick Pay Arrangements

A sick pay leave may be cumulative, meaning that employees are permitted to carry unused sick
leave days from one year into next year, or non cumulative, meaning that employees must forfeit
any sick leave that remains unused at the end of the year.

In cumulative plans, employers may allow employees to carry unused sick days over from year to
year, up to a maximum number of days. They may also allow employees to cash in unused sick
leave either at the end of the year, upon leaving employment, or upon retirement, at a rate of pay
determined by the employer.

Disability Plans

Disability insurance is insurance that provides for the payment of amounts in place of a person’s
salary when physical or mental disabilities prevent the person from performing gainful
employment. Short-term disability payments generally refer to payments of a disability that is of a

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temporary nature, where the person’s ability to return to their employment is expected. Long-term
disability is a disability whose length is not ascertainable.

Workers' Compensation

Employees need to be assured that if they are injured on the job, their medical benefits will be
taken care of and they will receive some income continuation while they are unable to work.

The workers’ compensation program covers job-related injuries and illnesses. Income
replacement benefits are provided—at the employer’s expense—for disabilities that are
temporary or permanent, partial or total. Benefits are also provided to surviving dependents in the
case of job-related deaths. In addition, full medical care and, to a limited extent, vocational
rehabilitation are covered.

The benefit to the employer is that employees who are injured must turn to the workers’
compensation system as their exclusive means of redress. Employees covered by workers’
compensation do not have the legal right to sue a negligent employer in court for punitive
damages.

Types of Benefits

There are income replacement benefits for:

Temporary disabilities;
Permanent disabilities;
Death;
Partial as well as permanent disabilities;
Medical care needed to treat job injuries and illnesses, even if no compensable
income loss occurs; and In cases with identified rehabilitation potential, services aimed at
restoring employability.

Amount of Benefits

The minimum for total disability benefits is normally two-thirds of pre-disability earnings. This
amount is constrained by maximum weekly benefits that average about 90 percent of state
weekly wages. In most states, there is also a minimum benefit that is the lesser of a set figure or
actual earnings.

Death Benefits

Death benefits for surviving dependents are ordinarily set at one half to two thirds of the
deceased workers’ wage up to maximum limits similar to those for total disability.

Partial Disability

Partial disability benefits are less standardized, both in amount and method of computation.
Nearly all states have a schedule of impairments that can be clearly defined, such as loss of a
limb or loss of vision in one eye, for which predetermined numbers of weekly payments are
allowed. Moreover, all states have a separate arrangement for compensating partial disabilities
that do not fit on a schedule, such as back injuries. In these cases payments are based on a
determination of:

The workers’ overall impairment as a percentage of total impairment;

Workers’ predicted wage-earning capacity as compared to predisability earning capacity; or
The record of actual wage losses due to the disability.

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Tax Consequences

Workers’ compensation benefits are not subject to state or federal taxation. Consequently,
actual replacement rates are higher than nominal rates, especially at higher income levels.

Legal Requirements

State law mandates workers’ compensation. Each of the fifty states has a workers’ compensation
law; forty-seven states make coverage mandatory. Only three states—New Jersey, South
Carolina, and Texas—give employers the option of declining coverage.

NOTE: Even where permitted, declining coverage is risky business, because it means the
employer can be sued for punitive damages if an employee becomes injured through the
employer’s negligence. And, that will almost certainly be more costly than the workers’
compensation premiums would be.

Employers Covered

Whether an employer is required to participate in a state’s workers’ compensation system

depends on the number of people employed and, in some cases, the type of business. State
workers’ compensation laws spell out these requirements. For example, state law may not require
coverage for domestic or casual employees; charities also may have the option of declining
coverage.

NOTE: Independent contractors are not covered by workers’ compensation because they are not
employees. This is also a focus of concern in the current controversy over health care, and will
likely be addressed in any healthcare reform legislation.

Family and Medical Leave

The Family and Medical Leave Act of 1993 (FMLA) is intended to provide a means for employees
to balance their work and family responsibilities by taking unpaid leave for certain reasons.

The FMLA applies to any employer in the private sector who is engaged in commerce or in any
industry or activity affecting commerce, and who has 50 or more employees each working day
during at least 20 calendar weeks or more in the current or preceding calendar year.

This law entitles most employees to take up to a total of 12 weeks per year of leave:

To care for a child newly born to the employee or newly adopted or accepted into foster care by
the employee; To care for certain seriously ill relatives; and/or Because of a serious health
condition that prevents an employee from performing the functions of the job.

Although there is no salary continuation requirement, employers granting FMLA leave must
continue the employees' health care benefits, provided that the employees continue to pay any
employee share of the premium. Employers must restore employees returning from FMLA leave
to their old jobs or to an equivalent position with equivalent benefits, pay, and other terms and
conditions of employment. Employers are prohibited from discriminating against or interfering with
employees who take FMLA leave.

The Department of Labor (DOL) has taken significant steps to enforce FMLA legislation, and
resolved 42 percent more complaints under FMLA in fiscal year 1998 than it did in the
previous year, with no increase in the number of complaints received. The agency settled 3,795
complaints in 1998—the highest number of FMLA enforcement actions completed in FMLA's five-
year history.

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According to the DOL, the most frequent employee complaint (44 percent) is that employers
refused to reinstate them to the same or equivalent positions under the FMLA. In 22 percent of
the complaints, employees charged employers with refusal to grant FMLA leave, while 16 percent
complained that employers interfered with or discriminated against employees for using FMLA
leave.

FMLA Notice Requirements

Employers have a number of notification and record-keeping obligations under the FMLA.

Poster

Employers are required to post a notice for employees that outline the basic provisions of FMLA
and are subject to a civil money penalty for willfully failing to post such notice. Employers have
the choice of obtaining the official posters from the Wage and Hour Division of the Department of
Labor (http://www.dol.gov/) or copying the text of the poster on 8 1/2-by-11-inch paper.

Explanations in Handbooks or Other Explanations of Benefits.

Employers that provide handbooks or other written guidance to employees to explain their rights
to benefits or leave must include an explanation of employees' FMLA entitlements.

Explanations Given to Employees Requesting FMLA Leave.

Employers that do not furnish written guidance about FMLA leave and other benefits must provide
written guidance when an employee requests FMLA leave.

In addition, employees giving notice of their need for FMLA leave must receive the following
employer-specific information, where applicable:

That the leave they are requesting will be counted against their annual FMLA leave entitlement;
Any requirements for the employee to furnish medical certification of a serious health condition,
and the consequences of failing to provide certification; The employee's right and/or obligation to
substitute paid leave for unpaid leave and any conditions related to the substitution;
Requirements and procedures for paying health care premiums during leave, for employees who
normally are required to contribute to the cost of their health care premiums; Any requirement for
employees to present fitness-for-duty certificates to be restored to employment, for employees
who are themselves seriously ill; The employee's status as a "key employee," if applicable, and
the potential consequence that restoration may be denied following FMLA leave, explaining the
Conditions required for such denial; The employee's right to restoration to the same or an
equivalent job on returning from leave; and The employee's potential liability for reimbursing the
employer for its share of health care premiums if the employee fails to return to work and cannot
excuse the failure as due to reasons beyond the employee's control.

This information is contained in Form Employer Response to Employee Request for Family or
Leave, which reproduces the model "Employer Response to Employee Request for Family or
Leave," issued by the DOL. The form incorporates wording from the DOL pertaining to the of
health insurance premiums, as well as the definition of "key employee."

Record-Keeping Requirements.

Employers must keep records disclosing basic payroll information, including employee name,
address, occupation, rate of pay, and terms of compensation; daily and weekly hours worked per
pay period (some employers not subject to the Fair Labor Standards Act need not keep records of
hours); additions to or deductions from wages; and total compensation paid. In addition,
employers must keep the following FMLA-related records:

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Dates FMLA leave is taken by employees (records must distinguish leave designated as "FMLA
leave" from non-FMLA leave, including leave provided under state law or voluntary employer
practices); Hours of leave, when taken in increments of less than a day; Copies of employee
notices of leave, when furnished to the employer in writing; Copies of all general and specific
notices given to employees to meet FMLA requirement; Documents describing employee benefits
or employer policies and practices regarding the use of paid and unpaid leave; Records
disclosing premium payments of employee benefits; and Records of any disputes with
employees about whether leave should be designated as FMLA leave.

Employers must keep records for at least three years. Records of medical certifications or
recertifications—whether concerned with employees or with their family members—must be
treated as confidential medical records and kept in separate files.

Policy Considerations

There are a number of concerns that employers will need to address when drafting policies
and forms to comply with the FMLA.

Compliance with State and Local Law.

At present, a number of states have family leave laws that use different formulas for determining
entitlement to leave and/or define family members or illness somewhat differently. Employers
operating in those states must comply with both state and federal law. This may mean that the
employer must determine each employee's leave entitlement under two sets of rules, granting
leave if it is required under either rule.

Integrating Voluntarily Provided Benefits with Mandated Benefits.

Employers that provide paid sick leave have to determine how to integrate this with FMLA
Medical leave, which need not be paid.

Granting Leave to "Key" Employees.

Employers should determine whether they prefer to preserve their right under the law to assess
the impact on the business before granting leave to higher-paid employees or to keep their
policies simpler to administer by granting equal FMLA rights to all employees.

Whether to Have Separate Policies for Sick Leave and Family Leave.

Since time available for personal medical leave is reduced by the time taken in the same year for
family leave, it may be convenient to issue a single policy (see Forms: Policy on Family and
Medical Leave Act and Sample Family and Medical Leave Policy). On the other hand, medical
leave raises special issues (e.g., integration of unpaid leave with paid sick leave and obtaining a
doctor's certification when the employee returns to work after a lengthy absence) and may merit a
separate policy and/or separate application form.

Whether to Require a Doctor's Certificate from Employees Returning from an FMLA

Medical Leave.

While employers may require employees to certify their fitness to return to work, the requirement
can only be imposed as part of a uniformly applied policy. Many employers already have policies
requiring medical certificates from employees who are returning to safety-sensitive jobs and/or
returning from leaves that exceed a specified period.

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Employers who do not already have policies requiring medical certificates from employees, who
are returning to safety-sensitive jobs and/or returning from leaves that exceed a specified period,
would be advised to devise such policies. Form: Certification of Health Care Provider reproduces
the model "Certification of Health Care Provider" provided by the DOL. This form includes
wording from the DOL pertaining to what is meant by a "serious health condition" under the
FMLA.

If an employee fails to provide certification within a reasonable time, the employer may deny
continuation of the leave; if an employee fraudulently obtains FMLA leave, the employee is
entitled to neither job restoration nor health benefits. Employees must be given at least 15 days
after a request for certification to comply with the request and can take longer if 15 days is not
practicable. The employer may choose to furnish a description of the essential functions of an
employee's job with the certificate; furnishing job descriptions to the certifying physician certainly
makes fitness-to-work certification more meaningful.

Tracking Leave Balances.

Since relatively few employees can afford unpaid leave, employers may not wish to monitor
employees' FMLA leave balances on an ongoing basis. It may be cost-effective to determine the
amount of leave available to employees by performing ad hoc calculations when leave is
requested. Other employers may, however, find it convenient to track total FMLA leave used
during the FMLA leave year on payroll or other records.

Determining What 12-Month Period to Use in Calculating FMLA Leave.

Since a qualifying employee can take up to 12 weeks of FMLA leave every 12 months, the way
the 12-month period is measured is critical. However, the DOL regulations allow employers to
measure the 12-month period by using any one of four methods consistently. The first two
methods are clearly the simplest to administer but could potentially entitle an employee to take as
much as 24 weeks of leave together; the other two methods minimize the leave available to
employees. The four methods involve using:

1.A calendar year;

2.Any fixed 12-month "leave year," such as a fiscal year or a year measured from the employee's
service anniversary;
3.The 12-month period measured from the date any employee's first FMLA leave begins; or
4.A rolling 12-month period measured backward from the date an employee uses any FMLA
leave.

Form Changes in FMLA Leave Year Calculations can be used to explain to employees when an
employer changes the 12-month period.

Determining Whether Paid Leave Qualifies as FMLA Leave.

Employers may wish to change the process of applying for paid sick or annual leave-and the
leave request forms-to obtain the information they need to determine whether the paid leave is for
an FMLA-qualifying purpose and, therefore, should count toward the 12 weeks.

If Employees Pay All or Part of Health Premiums, How and When to Collect Applicable
Premiums.

The FMLA regulations allow a number of approaches, including requiring payment at the time that
a payroll deduction would ordinarily be made or using the same payment schedule that applies to
Consolidated Omnibus Budget Reconciliation Act (COBRA) beneficiaries. The employer must set
up a mechanism for collecting premiums and notifying affected employees.

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Changing Vocabulary.

Much of the business world's vocabulary for different types of leave evolved under rules that are
now obsolete for all but the smallest employers. The distinctions between sick leave, medical
leave of absence (or disability leave), maternity leave, and parental leave are not eliminated by
the FMLA, but they have changed, and may in some cases have become less meaningful.
Employers may want to refer to leave to which employees are entitled under the FMLA as "FMLA
leave" or "FMLA leave of absence," since the DOL poster explaining employees' FMLA rights
makes frequent reference to "FMLA leave," as do the regulations implementing the FMLA. Those
employers that employ fewer than 50 employees and therefore are not covered by the FMLA
should, by contrast, be careful not to refer to FMLA leave in their forms or policies, to avoid giving
employees the impression that the employer intends to comply with the FMLA on a voluntary
basis.

Because of these variations-in state laws, in existing employer sick leave practices, and in
employers' likely response to discretionary matters—the policies that employers adopt in
response to the FMLA are likely to vary significantly. Forms Policy on Family and Medical Leave
Act and Sample Family and Medical Leave Policy is a policy statement designed to satisfy FMLA
requirements for an employer that provides some paid sick leave; however, it represents only one
approach. Forms Request for Family Leave and Request for Medical Leave of Absence are
employee applications for, respectively, family leave and medical leave of absence.

Return-to-Work Programs

So-called "return-to-work" programs, which facilitate an injured employee's returning to productive

work as soon as medically appropriate, grew out of employers' efforts to reduce workers'
compensation costs. When properly administered, the programs can also be beneficial to
recovering employees. In addition, the expertise and attitudes developed in sponsoring a return-
to-work program can also prove valuable in meeting the employer's legal obligations under the
Americans with Disabilities Act to make reasonable accommodations for disabled applicants and
employees. Form Policy on Return to Work after Serious Injury or Illness is a return-to-work
policy.

Religious Leave

Employers must make provisions for religious observance by workers under Title VII of the Civil
Rights Act of 1964. But, employers are not specifically required to provide paid leave or to make
an accommodation that would cause the company “undue hardship.”

Title VII requires employers to “reasonably accommodate” the religious beliefs of employees.
Each employer must determine what constitutes fair treatment of religious employees within its
work force with regard to days off. How much time off is permitted and whether the absences are
to be paid depend on the company’s general leave policy.

Options

Some companies schedule certain holidays—those recognized as a state holiday in many states
—as separate paid holidays. But, this is not enough. Some businesses provide a fixed number of
paid days off for religious observance; in this scenario, employees are not entitled to take time off
unless it is needed for religious purposes. The employer may allow employees to take several
hours off from work to attend services or perform religious ceremonies, or to refrain from work
entirely on holy days.

The policy of most businesses to fulfill the rules in this area is to allow individuals to use paid
personal days, allotted to all employees, or vacation days for religious observance. When

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employees who are permitted to use personal and vacation days for religious purposes deplete
their allotment of paid time off, the employer may either:

Arrange for the employee to work a flexible schedule (or trade shifts with another employee) to
make up the missed work time for extra days taken; or Allow the employee to take unpaid leave.

Required Accommodation

Courts normally will not expect an employer to grant either paid leave or unpaid leave for religious
purpose when it will become disruptive of the work schedule and or produce hardship. The
Supreme Court has held that requiring a company to bear more than a minimal cost to
accommodate an individual's religious belief could be considered an undue hardship.

Although a company must make some attempt to accommodate religious practices, it need not
adopt an employee’s specific proposal for accommodation. It is the employer’s right to select the
accommodation plan that is least disruptive and most convenient to the employer. The policy
should be equitable with other procedures when granting leave.

If any employee voluntarily agrees to a specific work situation that is expected to result in
frequent time conflicts with religious observance, the employer is not likely to be held responsible
for failing to adjust the duties of the new position to accommodate the employee’s religious
needs.

Voting Leave

While there is no federal statute on voting leave, many states have passed laws that require
employers to grant employees time off to vote. Whether they are subject to state statutes,
employers generally allow some leeway in employee arrival or departure on days when a national
election or important state, city, or county election is held. Usually, pay is not deducted for missed
work time.

Most of the state statutes governing voting leave regulate the amount of time permitted away
from the workplace to vote, whether wages may be deducted, and which elections are subject to
such regulation. Some states also require employers to apply formally for time off to vote. Form
Employee's Request to Take Voting Leave is an example of such an application.

In some states without voting leave statutes employers are not bound by specific rulings
regarding voting. However, the courts generally regard unfavorably any employers that may be
perceived as obstructing an individual's right to vote. Employers can eliminate this danger by
including a voting leave policy in employee handbooks. In establishing a voting leave policy,
employers may either allow workers to arrive late or leave work early to vote, or they may set
aside a certain number of floating hours that employees may use to vote.

Jury Duty

Employees who are U.S. citizens may be called on periodically to serve as jurors within the court
system, and employers are generally obliged to permit their absence for performance of this
public service.

Employers allow work-time off to perform jury duty, often without requiring them to forgo pay.
Within certain constraints of the law, employers can influence the timing of jury service to
requesting postponements from the courts.

Jury Duty Leave

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The Federal Jury System Improvement Act makes it unlawful for employers to discriminate
against or discharge an employee summoned to serve as a juror in any court of the United
States. Many states similarly protect employees summoned to serve as a juror or witness in state
court. Federal and state laws generally do not require employees to be paid for jury or witness
duty time off, although some states require a minimum form of salary continuation for jury duty
time. Federal and state laws require that:

 Employees on jury leave be treated as other employees on leaves of absence with respect to
benefit continuation.

 Employees be reinstated to their former positions after jury duty service is completed.

Many employers have a policy of paying their employees their salary during periods of jury duty
leave, or the difference between their normal salary and the amount received from the court for
serving as a juror. Such voluntary employer payment periods typically last from 10 to 15 days.

It should be noted that federal wage and hour regulations specify that employers may not make
deductions from an exempt employee's salary for absences caused by jury duty or attendance as
a witness. Such deductions would destroy the employee's status of being paid on a salaried basis
and, consequently, the employee's status as "exempt" under the Fair Labor Standards Act.
Employees may, however, offset any amounts received by employees as jury or witness fees.

The regulations also provide that employees need not be paid for any workweek in which they
perform no work. Because many exempt employees perform some work during periods of jury
duty, however (e.g., at home in mornings, evenings, or on weekends), employers should be
careful not to take any action with respect to an exempt employee's wages inconsistent with
these regulations. Indeed, even if a minimal amount of work is performed during any given
workweek, the employee would be required to be paid his or her normal weekly salary, less any
offset, of course, for jury or witness duty.

Veterans' Rights

The Uniformed Services Employment and Re-employment Rights Act of 1994 (USERRA) protects
veterans who have left an employment position (other than temporary) to perform training or
service in the armed forces. For the first time, Coast Guard personnel are treated equally with
other uniformed service personnel. USERRA, which replaces the old Veteran's Re-employment
Rights statute, took effect on December 12, 1994, and applies to veterans coming back to work
after that date. USERRA also may apply to employees who left employment for active duty within
the past five years, but who have not yet returned from service.

USERRA provides that an employee or his or her dependents who have coverage under an
employer's health plan must be offered continuation coverage for up to 18 months after
commencement of military service. With the exception of service-connected conditions as
determined by the secretary of veterans' affairs, if coverage under the health plan is terminated
because of military service, an exclusion or waiting period may not be imposed on the employee
(or family member) when the employee is re-employed.

USERRA applies to all traditional pension plans and defined contribution plans such as profit
sharing plans, 401(k) plans, Employee Stock Ownership Plans (ESOPs), money purchase plans,
and other deferred compensation arrangements. Returning veterans have a right to plan benefits
with no break in employment service, no forfeiture of benefits already accrued, and no necessity
to requalify for participation. Upon re-employment, service in the military will count as
employment service for purposes of vesting and for determining the accrual of benefits.

The returning veteran is entitled to an employer contribution that he or she would have received if
such person had remained continuously employed. The rate of compensation to calculate

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pension benefits would be the (a) rate of pay the employee would have received if not on military
leave (this would include wage increases and bonuses) or (b) if it is not "reasonably certain" what
the pay rate during the military absence would have been, the employee's average earnings
during the 12 months (or shorter period, if applicable) prior to military service.

For plans that allow elective deferral contributions or after-tax employee contributions, the veteran
may make such contributions after returning to employment. The employer must make any
matching contribution that would have been made under the plan. The matching contribution may
not exceed the amount that the person would have received if he or she had remained
continuously employed. The repayment period can be made over a period of three times the
period of military service, not to exceed five years.

The plan is not required to credit earnings that would have been credited if the make-up
contribution had been made during the leave, nor is it required to allocate forfeitures for that
period to the returning veteran.

Re-employment Rights.

A person who is absent from work by reason of "service in the uniformed services" will be entitled
to the re-employment rights and benefits of this Act if:

 The person has given notice of impending military service;

 The cumulative length of absence from his or her employer by reason of uniformed services
does not exceed five years; and
 The person submits an application of re-employment.

The obligation to provide notice is waived if the giving of notice is precluded by military necessity
or is otherwise impossible or unreasonable. Further, service beyond five years is permitted for
training, involuntary active duty extensions, and to complete an initial period of obligated service.

The term "service in the uniformed services" means the performance of duty on a voluntary or
involuntary basis in a "uniformed service" and includes:

 Active duty;
 Active duty for training;
 Inactive duty training;
 Full-time National Guard duty; and
 A period for which a person is absent from a position of employment for the purpose of an
examination to determine the fitness of the person to perform any such duty hereinafter
referred to as "uniformed service" or "military duty").

The "uniformed services" include the armed forces, the Army National Guard, and the Air
National Guard when engaged in active duty for training, inactive duty training, or full-time
National Guard duty; the commissioned corps of the Public Health Service; and any other
category of persons designated by the president in time of war or emergency.

An employer is not required to re-employ an individual if its circumstances have so changed that
it makes such re-employment impossible or unreasonable; if the accommodation, training, or
effort required under USERRA would impose an undue hardship; or the individual's employment
prior to military service was for a brief, nonrecurrent period and there was no reasonable
expectation that it would continue indefinitely. The employer has the burden of proving the
impossibility, undue hardship, or the brief nonrecurrent nature of the employment.

Application for Re-employment.

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After completion of uniformed services, the period of time in which the veteran must apply for re-
employment is based upon the time away from the employer:

Less than 31 days away from employer: report on first full regularly scheduled work period on the
first calendar day following the expiration of eight hours after a return to his or her home;

31 days or more but less than 181 days away from employer: report no later than 14 days after
return;

More than 180 days away from employer: report no later than 90 days after return;

Hospitalized or convalescing from an injury caused or aggravated by active duty:

report at the end of the period necessary to recover from such illness or injury; not
longer than two years.

A person who fails to report for re-employment within the above time period does not
automatically forfeit his or her right to the benefits under USERRA, but will be subject to the
employer's conduct rules, established policy, and general practices pertaining to explanations and
discipline with respect to absence from scheduled work.

Retention Rights.

USERRA provides rules governing the length of time following return from military duty that
veterans are protected from termination without cause. Veterans who serve more than 30 but less
than 181 days cannot be terminated without cause for 180 days following their date of re-
employment. Those serving more than 180 days are protected for one year. Veterans whose
military service lasts less than 31 days do not have this termination protection. However, they will
still be protected from discrimination because of military service or obligation.

Accrued Leave or Vacation Pay.

Any employee whose employment is interrupted (including temporary employees) may use any
vacation or annual, or similar, leave that was accrued prior to the military service. The person
cannot be forced to use vacation or accrued leave for military service.

Documentation upon Return.

An employer can request documentation that establishes the timeliness of the application for re-
employment and the length and character of service. An individual is not entitled to the benefits of
USERRA if he or she is separated from the uniformed services under other than honorable
conditions.

Even if documentation is not available, the employer must re-employ the individual until the
documentation becomes available. However, documentation can be required before making
retroactive pension contributions.

Position to Which Entitled upon Re-employment.

The objective of USERRA is to restore the veteran to the position that such person would have
obtained had he or she remained continuously employed (the "escalator position") unless the
employer can prove that he or she is not qualified for that position. The veteran is also entitled to
full seniority benefits. Rights and benefits that are determined by or accrue with length of service
are seniority benefits.

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If an individual served less than 91 days in the uniformed services and the employer proves such
person not qualified for the escalator position after reasonable efforts, the employee would be re-
employed in the position he or she left.

If the individual served 91 days or more in the uniformed services and such person is proved not
qualified for the escalator position after reasonable efforts by the employer, the employer would
be obligated to re-employ the person in a position of like seniority, status, and pay. If, after
reasonable efforts by the employer, the veteran is not qualified for such position, the veteran
would be re-employed in the position that he or she left. If no longer qualified for that position, the
employer would re-employ the veteran in any other position of like seniority, status, and pay.

Finally, regardless of the period of time served in the uniformed services, if the veteran is not
qualified after reasonable efforts by the employer for any of the above positions, the veteran must
be re-employed in any other position of lesser status and pay for which such person is qualified,
with full seniority benefits. Regardless of the position for which the veteran is qualified, such
person is entitled to the full seniority benefits that he or she would have attained if the
employment of such person had not been interrupted for service.

Leave of Absence Benefits.

In addition to being entitled to rights and benefits that are determined by seniority, the individual
who leaves employment for uniformed service would also be entitled to the same rights and
benefits "generally provided" to other employees on a leave of absence. The individual can be
required to pay the employee cost, if any, of any benefit to the extent that other employees on a
leave of absence are required to pay.

A person who is absent from employment by reason of service and knowingly provides written
notice of intent not to return to a position of employment after service is not entitled to the rights
and benefits accorded to other employees on furlough or leave of absence. The employer has the
burden of proving that the person knowingly provided written notice and understood the
consequences of such a waiver. The notice applies only to the furlough or leave of absence
benefits. A person would still be entitled to other rights and benefits under USERRA, particularly
reemployment rights.

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Health Insurance:

Introduction

This section discusses employer-provided health insurance, including administration, funding, tax
Consequences and legal compliance. In addition, it outlines some of the popular policies and
Options.

For most employees, health care is the most important employer-provided fringe benefit. It is for
this reason that many employers offer medical insurance coverage, even though law does
generally not require such coverage. In fact, most companies with over 100 employees offer
some type of health insurance.

Although this section deals mainly with the "mechanics" of choosing, setting up and administering
a health plan, as well as some of the tax and legal implications—it is necessary to first define
several terms commonly used in relation to various types of plans.

Fee-for-Service Plan.

In a fee-for-service arrangement, the insurance carrier will reimburse the member for each
medical service provided. As there are many variations, there may be deductibles and other
limitations on reimbursement, depending on the particular plan.

Health Maintenance Organization (HMO).

HMOs are becoming increasingly popular, as they are often the most cost-effective of the various
health plans available to an employer. An HMO generally contracts with a number of health care
providers—its "network." HMO members pay a set fee each year for a predefined package of
services. Members must use providers in the "network" to obtain free (or fully reimbursed) care
(occasionally subject to a predefined co-payment). HMO care often requires members to chose a
Primary Care Physician (PCP), who acts as a "gatekeeper" to coordinate members' care.
Approval of the PCP is generally required before a member can see a specialist. This feature has
come under heavy attack of late. As a result, many HMOs now offer a modified service, which
allows members to choose from among a predefined list of its "participating" specialists, which
can be visited without a referral from the PCP.

Point of Service Plan (POs).

A PO plan combines some features of a typical fee-for-service plan with those of a prepaid
managed care arrangement. These plans often allow you to use in-network or out-of-network
providers. Typically, the plan will cover all (or most) of the cost of in-network providers, while
those using out-of-network services will incur co-pay and/or deductible out-of-pocket expenses.

Preferred Provider Organization (PPO).

A PPO is a managed care plan that combines some features of a fee-for-service plan. Depending
on the specific plan, a PPO may operate similar to a POs, or it may provide coverage at a set fee
when a member visits a Preferred Provider and a lower reimbursement rate (and therefore higher
Out-of-pocket costs) for providers that are not on the "preferred" list.

Retiree Medical Benefits

Retiree medical benefits are a matter of great concern to both employers and employees. For the
employer who is committed to providing such benefits, rising costs cause concern. Costs are
rising as people are living longer.

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The first action the employer will want to take is to review its commitment to the employee. One
major concern is whether it is binding or not. For example, if the agreement is found in a union
contract, and is clearly found to be in force, then an obligation exists—versus something that may
be interpreted to be implied in a manual.

It has been held that the plan description (SPD) required by ERISA and distributed to employees
controls. If the SPD reserves the right of the employer to alter, modify, or eliminate the plan—
which many do—this may override any implied promise of lifetime or no-cost medical benefits
contained in an employee manual or brochure.

Care should be taken to review terms used in manuals or brochures to make sure that the
intention of the employer is being properly communicated. If promises are made, their binding
nature could be costly.

Each employer should make a cost-benefit analysis in terms of its own workforce, age categories,
turnover rate, health state, and all other factors bearing on the present and future costs. On the
benefit side, the employer will want to consider what is being offered by competitors tapping the
same labor pool and what effect this will have on recruitment and retention of talent.

Compliance with Federal Laws

If an employer does choose to offer health care coverage, it must comply with several federal
laws. The most notable of these are:

The Employee Retirement Security Act of 1974 (ERISA), which contains various reporting and
Disclosure rules, The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA),
which includes provisions pertaining to continuation of coverage, The Americans With
Disabilities Act of 1990 (ADA), which affects health plan design and administration, and
The Health Insurance Portability and Accountability Act of 1996 (HIPAA), which addresses
the issue of portability, specifically in light of coverage of pre-existing conditions.

Unlike other employer-provided benefits such as pensions, an employee usually is entitled to

begin receiving benefits shortly after commencing employment.

Tax Considerations

As long as the employer's group health plan satisfies certain nondiscrimination and qualification
requirements, the premium it pays for such coverage and the benefits received from it are
generally excluded from the employee’s income. Moreover, an employer’s costs associated with
its employee health plan generally will be deductible as an ordinary and necessary cost of
business, regardless of the ultimate tax treatment of the benefits to the recipients.

Tax Consequences to the Employer

Insurance premiums and other costs associated with an employer's health plan generally will be
deductible for tax purposes, as an "ordinary and necessary" cost of doing business, regardless
of the ultimate tax treatment of the benefits to the recipient.

NOTE: Group health plans must often comply with state law, as well. For example, in New York,
an employer may not claim a deduction for any amounts paid or incurred in connection with a
group health plan if the plan fails to reimburse hospitals for inpatient services provided in New
York State at the same rate that commercial insurers licensed in New York are required to
reimburse hospitals for inpatient services for individuals not covered by a group health plan. The
same rule applies to plans that provide inpatient hospital services through a health maintenance
organization (HMO) or through a Blue Cross and Blue Shield corporation.

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Tax Consequences to the Employee

The value (premiums paid) of health insurance coverage is generally not considered income to
the employee, and is therefore not included in income for tax purposes. Similarly, the
reimbursements for actual medical expenses paid by the insurance carrier are generally not
included in income.

Although, to be deductible by an individual, medical expenses generally must rise above a 7.5%
(of Adjusted Gross Income) "floor," employer-provided reimbursements do not have to exceed a
certain floor. However, amounts received by an employee as payment for personal injuries or
sickness under an accident or health insurance plan, are included in gross income, to the extent
they are attributable to employer-paid premiums that were not included in the employee’s taxable
income (or were paid directly by the employer).

Qualifying Medical Care

Employees may be entitled to an itemized deduction for expenses paid for "medical care" if that
care is not covered by the employer's health plan (or if the employee is not covered by any health
plan). Such expenses may be paid for the medical care of the employee, a spouse, or a
dependent.

The term "medical care" is broadly defined in the tax law to include amounts that may not even be
Covered under a health insurance plan. Expenses that will be considered to be incurred for
“medical care” include amounts paid for the following:

The diagnosis, cure, mitigation, treatment or prevention of disease. The purpose of affecting any
structure or function of the body. Transportation primarily for and essential to that medical care,
and Insurance premiums covering such medical care.

NOTE: Under the tax law definition, many medical expenses not covered by health insurance are
tax-deductible, subject to certain limitations. These may even include certain capital expenditures
for home improvements that are added primarily for the medical care of the individual, or to
accommodate a physical handicap.

More particularly, medical expenses can include:

Hospital services;
Nursing services;
Medical, surgical, nursing, dental and other healing services;
Laboratory, X-ray, and other diagnostic services; and
Medicine and drugs.

Medicine and drugs include all medications, whether or not a prescription is required, although a
deduction is available only for expenses for prescription drugs and insulin.

NOTE: Cosmetic surgery is not generally considered “medical care” unless it corrects a deformity
caused by a congenital abnormality, or a personal injury due to accident, trauma, or disfiguring
disease.

Expenses for transportation and lodging away from home essential to medical care may also be
treated as expenses incurred for medical care—subject to qualifications and limitations. Also,
some types of institutionalization, such as attending a special school for a mentally or physically
handicapped individual, are considered medical care—if the principal reason for being
institutionalized is for the medical resources provided by the institution, for alleviating such
handicap.

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COBRA Continuation Of Coverage

Federal law requires most employers with group health plans to offer employees and their
spouses and dependents a temporary period of continued health care coverage if their employer-
provided coverage should cease. These continuation requirements are commonly referred to as
COBRA (the Consolidated Omnibus Budget Reconciliation Act of 1985).

COBRA contains requirements for group health plans to provide continuation coverage to
covered employees and their “qualified beneficiaries” upon the occurrence of a “qualified event.”

Generally, an employer with 20 or more employees must continue to offer coverage in their group
health plan to certain former employees, retirees, spouses, and dependent children. The length of
continuation coverage offered depends on the "qualifying event."

COBRA Qualifying Events

Qualifying events are certain types of events that would otherwise cause an individual to lose
health coverage—if not for the COBRA provisions. The type of qualifying event will determine
who is entitled for continuation coverage and the required amount of time that the plan must offer
the health coverage under COBRA.

Under COBRA, the affected employee or family member may qualify to keep their group health
plan benefits for a set period of time, depending on the reason for losing the health coverage.
The following represents a basic overview of some basic information on periods of continuation
coverage.

Beneficiary Qualifying Event Period of Coverage

Employee, Spouse, Termination Reduced 18* Months
Dependent Child hours
Spouse, Dependent Employee entitled to 36 Months
child Medicare,
Divorce or legal
separation,
Death of covered
employee
Dependent child Loss of dependent 36 Months
status

*This 18-month period may be extended for all qualified beneficiaries if certain conditions are met
in cases where a qualified beneficiary is determined to be disabled under COBRA.

In general, employers must offer coverage for a period of up to: 18 months for covered
employees, as well as their spouses and dependents, when health plan coverage is lost due to
termination or a reduction of hours. 36 months for spouses and dependents who lose coverage
due to divorce or legal separation, the employee's death, or another specified "qualifying event."

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However, COBRA also provides that your continuation coverage may be cut short in certain
cases.

The Health Insurance Portability and Accountability Act

The Health Insurance Portability and Accountability Act (HIPAA), signed into law by President
Clinton on August 21, 1996, offers protections for millions of American workers that improves
portability and continuity of health insurance coverage.

HIPAA protects workers and their families by:

limiting exclusions for preexisting medical conditions; provides credit for prior health coverage
and a process for providing certificates concerning prior coverage to a new group health plan or
issuer; provides new rights that allow individuals to enroll for health coverage when they lose
other health coverage or add a new dependent; prohibits discrimination in enrollment and in
premiums charged to employees and their dependents based on health status-related factors;
guarantees availability of health insurance coverage for small employers and renewability of
health insurance coverage in both the small and large group markets; and preserves the states’
role in regulating health insurance, including the states’ authority to provide greater protections.

Medical Savings Accounts

For a limited time, beginning in 1997, certain individuals (those who work for companies with 50
or fewer employees or are self-employed) may participate in a medical savings account (MSA)
plan. The plan has two basic components:

1.A catastrophic health insurance policy with a high deductible (for individual coverage, at least
$1,500; for family coverage, at least $3,000) and

2.A medical savings account.

A company that begins an MSA plan while it has 50 or fewer employees may continue to offer the
plan after it exceeds 50 employees if certain conditions are satisfied but only as long as the
number of employees does not exceed 200

Under an employer MSA plan, the employer provides the catastrophic policy. The employer or the
employee may make tax-free contributions to the MSA, but not in the same year, and annual
contributions are limited to a percentage of the policy deductible—65 percent for those with
individual coverage, 75 percent for those with family coverage.

An employee may make tax-free withdrawals from the MSA for routine medical bills or
deductibles on the catastrophic policy; withdrawals for any other purpose are subject to income
tax and a 15 percent penalty unless made after age 65 or the onset of a disability.

Participation in the MSA program is limited—it is a four-year test program, and the total number of
MSAs is limited to 750,000 during the test period. Banks and insurance companies that market
MSAs must report sales to the Treasury Department, which will be responsible for determining
when the 750,000 cap is reached. To date, fewer than 100,000 MSAs have been set up.

As the law stands now, after December 31, 2000 the MSA provisions are set to expire. If allowed
to expire, no new MSAs will be permitted to be set up. But, anyone with an existing MSA will be
able to keep it and to contribute to it indefinitely.

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Life Insurance:

Introduction

This section describes the various types of insurance available and the most popular employer-
provided life and disability insurance coverage. This section also focuses on administration,
funding, tax consequences and legal compliance from the employers point of view and For
employees, it outlines some of the popular policies and options, as well as choices available to
supplement employer-provided coverage and employees not covered by a group plan.

Most employers provide some form of life and disability insurance to cover their employees.
Benefits are relatively inexpensive to obtain at group rates available to the employer and are
usually based on the employee's salary.

Group Life Insurance

Group life insurance is tax-free to the employee to up to $50,000; special Internal Revenue
Service tables apply if the amount is over $50,000. Typically, the employer provides a benefit of
one or two times annual salary and pays the full cost of insurance premiums.

Form Group Life Insurance/Accidental Death and Dismemberment Insurance Coverage Request
is an application for group life/accidental death and dismemberment insurance that also provides
for employees to purchase life insurance coverage for dependents through payroll deductions.
The accidental death benefit is an additional payment that the employee's beneficiary will receive
if the employee dies accidentally; this type of provision is common in insurance policies and is
also referred to as double indemnity or AD&D. If the employee elects to waive insurance
coverage, the employee should be asked to sign a waiver (see Form Waiver of Group Life
insurance and Dependent's Group Life Insurance). Such a waiver precludes the employee's
dependents from later arguing that the employer failed to provide promised life insurance.
Although there are no federal regulations requiring employers to offer continuation life insurance
coverage to terminated employees, employers or their insurers may choose to offer the continued
coverage.

Life insurance that is not part of a qualified group-term life insurance plan can be useful where the
employer wants to provide life insurance for a small group of key employees, but not for rank and
file employees. The cost can be considerably lower than a group-term life insurance plan
because there are no
anti-discrimination requirements. Even if the key employees' compensation is grossed up to
offset the extra tax due on the compensation used to purchase the insurance policy, the overall
cost to the employer may be less than the cost of providing insurance to all employees.

Tax Consequences

To receive favorable tax treatment, a group-term life insurance plan must:

Provide a general death benefit deductible from income in accordance with the tax code;
Be provided to all full-time employees;
Be provided under a policy carried by the employer;
Compute the amount of insurance under a formula that precludes individual selection; that is, as
a uniform percentage of compensation or under coverage brackets of the insurer;
Limit the evidence of insurability requirement to a questionnaire; and may not require a physical
exam.

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Types of Life Insurance

Life insurance is a contract between the policy owner and an insurance company under which the
company agrees to pay a specified sum to the designated beneficiary upon the death of the
insured, in return for premium payments. The basic types of life insurance products are term and
permanent insurance. All life insurance contains a pure death benefit element. Permanent
policies add a cash value component. The three major types of permanent insurance are:

Universal life;
Whole life; and
Variable life.

Whole Life

Whole life insurance policies enjoy a cash build-up feature. With whole life, the insured pays the
same annual premium for life, up to a specified age, at which time the cash surrender value
equals the face amount of the policy, and no further premiums need be paid. The conventional
whole life policy has fixed death benefits, maturity date, and level premiums. The progression of
cash surrender value is fixed also. Any change in coverage necessitates a catch-up of premiums
for an increase in coverage (or a refund if coverage is lowered). Some whole life policies contain
automatic adjustments.

The need for insurance can fit in different time frames:

Short-term needs

Some examples of short-term needs include a lender requiring that insurance be placed on the
life of a borrower until the loan is repaid and providing coverage for a spouse with young
children until the children grow older. Generally insurance that is needed for 15 years or less can
be considered short term.

Long-term needs

Generally, insurance that is needed for more than 10 or 15 years can be considered long term.

Permanent needs

A permanent need for insurance occurs where the need exists throughout the individual's lifetime
and is not expected to be eliminated. For example, providing liquidity in the estate to cover the
taxes and settlement costs would be a permanent need if the estate was comprised of mostly
illiquid assets and the individual had no intention of selling the business.

Term Insurance

Term insurance provides pure death benefit protection with no cash accumulation. Coverage is
typically for a fixed period of time and will cease at a given age. One-year renewable term
insurance is the most basic type of term insurance and generally carries the lowest initial cost.

Level Term Policies

When the need for insurance coverage is for a definite, fixed period, a level term policy might be
the best choice. These policies provide death benefit protection for only a fixed number of years
at a level premium that does not increase annually. Level term policies are available for periods
of 5, 10, 15, and, in some states, even 20 years. Most level term policies stipulate that at the end
of the fixed term, if policyholders want to renew their insurance, they must prove their insurability

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to obtain a new reasonable cost for the next period of years. If policyholders cannot prove that
they are in good health, the premiums will be prohibitively expensive.

Convertibility

Convertibility features vary greatly. Some policies are convertible to a permanent cash value
policy only during the first few years. For instance, a policy may provide for a level premium for
10 years but offer the
convertibility feature only during the first 5 years. If a term policy is convertible, then in
subsequent years the policyholder can determine more precisely the length of need and convert
the term policy to a permanent policy if the need is long term or stay with a term policy if the need
is short term.

Guarantee Period

Policies also vary with respect to the actual guarantee period. Premiums may be projected to be
level for a fixed period (e.g., 10 years) but in fact may be guaranteed for only 5 years. Although
term insurance is the most basic type of insurance, it has become quite complex.

Universal Life Insurance

Universal life insurance is a form of permanent insurance. Therefore it combines pure death
protection with cash value. The policy incurs a cost of insurance (increasing with age, similar to a
one-year term policy) and an expense cost, and the balance is accumulated as cash value, which
earns interest.

Targeted Premium

The targeted premium in a universal life policy can vary widely depending on how the agent
designs the policy. The targeted premium will be based on the following basic criteria (in addition
to various other internal assumptions):
Current interest rate being used;
Current cost of insurance being used;
Assumed cash value at a given age; and
Assumed years of premium payments.

Whole Life Insurance

Whole life is the most conservative form of permanent policy. It provides the strongest
guarantees. The most popular whole life products are offered through "mutual" companies, where
the policyholders in effect own the company. Policies offered through these companies have the
following features: The basic structure is designed so that if the policyholder pays the premiums
for life, at a specified age (usually 95 or 100), the cash value equals the face amount (death
benefit) and the policy matures.

Because the guarantees are based on very conservative assumptions, the companies pay annual
dividends. The dividend basically represents the excess of performance in various areas (e.g.,
investment earnings, mortality costs, and expense costs) above the assumed conservative
performance used in calculating initial premiums. These dividends can be used to reduce
future premiums, add to cash value, or purchase additional small pieces of insurance, which
increases the death benefit. Whole life contains more guarantees and less flexibility than a
universal life policy. Although contractually a policyholder may be required to pay the same
premium for life, when the cash value has built up after a few years, the policyholder can handle a
cash flow crisis by borrowing against the cash value. Dividends can be used to reduce or
eliminate premiums in future years.

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Variable Life

Variable life is most popular with the universal life type of policy design. The major difference
between a universal life and a variable universal life is that the policyholder bears the primary
responsibility for the investment selection. The company will offer choices of investments
(subaccounts) similar to but not the same as mutual funds. There will normally be a domestic
stock account, foreign stock account, fixed income account, and money market type of account.
Some companies will offer a wider variety of choices than others.

This type of policy was designed for individuals who prefer to absorb the investment risk and are
less conservative in nature. It can be an excellent tool for various purposes, including
supplements to other retirement vehicles. If an individual believes in the long-term advantages
of the equities markets and is comfortable with the short-term swings, this type of design may be
preferable to the standard universal life, where the company simply credits the cash value based
on its more conservative investment portfolio.
This decision must not be made in a vacuum, and asset allocation in the individual's overall
portfolio must be considered. As a very broad guideline, if it is believed that the long-term
performance of equities will exceed 9%, variable life should outperform other types of policies.
However, if the equity market performance of the variable life sub accounts does not exceed 9%,
the expenses and cost will negate any advantages.

Cost of Insurance Charges

One unique aspect of variable life is that funds are generally held in a separate account. This
separate account is generally protected from the creditors of the insurance company. Some
agents use this characteristic to suggest that a lesser quality company can be considered for
variable life because funds will be protected even if the company gets into financial difficulty.
However, they are overlooking one critical factor in the mechanics of variable life: because the
universal life design is used most often, the cost of insurance charges are segregated and
charged each year. If a company is in trouble financially, it can theoretically raise its costs of
insurance and expenses. This can have a significant impact on the ultimate performance of the
policy. Therefore, a solid carrier is still essential.

Second-to-Die Life Insurance

One of the basic objectives of estate planning is to provide liquidity at the time of death to pay
debts, administration expenses, and estate taxes in an orderly fashion. Life insurance is often
used to provide that liquidity. For example, in situations where closely held businesses, real
estate investments, and other illiquid assets comprise a significant portion of the estate, sufficient
funds may not be available to meet estate obligations. Proceeds from life insurance policies can
provide funds that might otherwise have to be raised by selling estate assets, possibly at
depressed market prices.

In the case of the estate of a married person, the estate tax can be eliminated at the death of the
first spouse entirely through the use of the marital deduction. If the bulk of the estate is left to the
surviving spouse, the burden of the estate tax must be faced at the death of the surviving
spouse, and life insurance can provide funds to meet that obligation.

The question arises as to which spouse should be the insured. Survivorship life insurance policies
have been designed to address this very question. Such policies provide for payment of the
insurance proceeds on the death of the second to die. Because payment of the proceeds is
delayed until after the death of both insureds, the cost of a survivorship policy will be less than the
combined cost of separate policies on each spouse.

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If structured properly, survivorship policies can be an excellent method of passing leveraged
assets to children and grandchildren. Grandparents can pay the premiums to purchase a
survivorship policy as a method of leveraging their $1,000,000 generation-skipping exemption.
The face amount of the policy can be a significant multiple of the premium costs. The proceeds at
the death of the second insured will be received free of estate and income taxes, under current
law, if structured properly. These funds therefore
will be able to escape estate taxes for more than one generation.

Some additional factors to consider when comparing second-to-die policies are:

What occurs at the first death?

Is there an increase in cash value?
Is there an increase in the cost of insurance?
Is the dividend scale changed?
What happens in case of a divorce?
What are the effects of a tax law change?

A few companies actually provide a cash infusion into the policy at the death of the first spouse.
This can be extremely beneficial. It can reduce future premium payments, which will be useful at
the death of the first spouse. Premium payments through an insurance trust are considered gifts
to the ultimate beneficiaries. These gifts often qualify for the annual tax exclusion. When both
spouses are alive, together they can absorb $20,000 per beneficiary.

Another technique for avoiding the first death gift issue is to purchase a first-to-die rider, which will
pay a specified benefit to the trust at the first death to the trust. These proceeds can then be used
by the trust to help pay the premiums in the future, resulting in reduced need for gifts from the
surviving spouse to the trust.

Variable Survivorship Policies

A variation on the classic second-to-die policy is a relatively new product called variable
survivorship life. These policies combine the features of classic second-to-die insurance with the
features of variable life. Some insurance carriers have recently come out with this product, and
many more intend to introduce new products in this area in the near future.

First-to-Die Policies

First-to-die insurance is basically whole life or universal life that pays at the first death of the two
insureds. It is primarily used to insure co-owners of a business where there is a buy-sell
agreement so that the proceeds are required to effect a buyout of the first deceased's shares in a
business (no matter which partner dies first). Some first-to-die policies cover as many as six or
eight insureds at a time. The objective is to avoid having to purchase multiple policies, which can
be more costly and cumbersome to administer. Some
questions to ask are:

What happens when one insured dies?

Does the coverage continue for the remaining insureds, or does the policy pay only once, at the
first death?
What are the tax ramifications?
Depending on the circumstances, the tax issues can become complex. If a simultaneous death
occurs, will proceeds be paid for both insureds or only one?

Another potential application of first-to-die insurance is for a married couple where both spouses
work and wish to have equal coverage. However, an analysis must be performed to determine

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whether the policy is beneficial. Most major insurance carriers do not offer first-to-die coverage. It
may be valuable in some situations, but a thorough analysis must be performed.

Split-Dollar Life Insurance

Split-dollar insurance is sometimes thought of as a means of providing executives with life

insurance protection at low cost. Split-dollar might be considered as a possible alternative to
group-term for non-executive retirees, as well.

Some policies are offered on terms that permit the cessation of premium payments after eight
years, for example. This could be helpful to the retiree. In addition, split-dollar, unlike group-term,
will provide the retiree with cash value.

Split-dollar insurance makes use of whole-life insurance to provide coverage for an employee.
Whole-life insurance has two components: pure life insurance, and a savings component, which
is equal to the cash value of the policy. A portion of the premiums paid on whole-life insurance
goes to provide the pure life insurance portion of the benefit, and a portion goes to increase the
cash value of the policy.

In a split-dollar insurance plan, the company pays the portion of the premium equal to the
increase in the policy’s cash value, and the employee pays the difference between the total
premium and the increase in the cash value. Upon the employee’s death, the employer receives
back the amount of premiums paid in, and the employee’s beneficiary receives the remainder of
the benefit under the policy. Thus, the company in effect provides a larger insurance benefit than
the employee would have been capable of purchasing on his own, while losing only the time
value of its money.

Tax Treatment of Split-dollar Life

An employer is not entitled to a deduction for the premiums paid in a split-dollar life insurance
plan because the employer is a beneficiary under the policy. The employee must include in
income the cost of the pure life insurance, minus any premiums paid. The amount of these
premiums is determined either from actual numbers, if available, or from IRS tables.

It is important to note that the employee does recognize income with respect to the whole life
portion of the insurance
policy.

Retiree Insurance Issues

Post-retirement Death Benefits

An employer may provide pre-retirement life insurance benefits and post-retirement death
benefits as incidental benefits to a qualified retirement plan. However, such benefits are usually
too limited to be of much use to an owner-employee.

A common goal of life insurance, especially for younger workers—is to create what may be
characterized as an “instant estate” for an insured who dies prematurely, before having had an
opportunity to build an estate.

A retiree's need for insurance does not conform to that proposition—if he has reached the normal
retirement age of 65, his subsequent death cannot readily be viewed as premature or as coming
before he has had an opportunity to build an estate.

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This being so, neither the retiree nor the retiree's former employer ordinarily will see any pressing
need for continuing coverage of the retiree under a group-term policy. If obligated to pay the
sharply escalating premiums as the retiree continues to age, the employer may experience a
pressing need to discontinue coverage.

The employer will generally not want to offer retirees continued group-term coverage, except as it
may be bound by an enforceable contractual obligation, either a union contract or an individual
employment contract. However, there may be special circumstances under which the employer
may want to provide long-term coverage to certain individuals, such as where the business is a
family corporation and the retiree is a family member or has had long service with the business,
or possibly where the retiree does not have long to live.

The individual retiree who needs or wants the planning benefits that life insurance offers may
want to take advantage of the privilege that most group-term policies offer, i.e. conversion to
permanent life insurance at level premiums. Permanent life insurance offers tax-free buildup of
cash value, conversion to an annuity, if that is thought to be desirable, and exclusion from estate
and income taxation of the proceeds if the requirements of the Code are observed.

It is important to note that if the employer pays the premiums for continuation of coverage, it will
be entitled to deduct those costs as a usual business expense. This is a benefit that should not
be overlooked.

Beyond the possible tax benefits, there are other ways an employer can limit the cost of
continuation insurance, including:

Getting some form of contribution for premiums from the retiree;

Limiting coverage to some specified age;
Using some form of decreasing term ending at a specified age; and
Treating the employer premiums payments or some part of them as loans, with or
without interest, and repayable out of the insurance proceeds.

Disability Insurance

Disability is by definition the worker's inability to work and earn income. Disability benefits
guarantee workers some income security during periods in which they may not be able to work
owing to poor health or other causes. Accordingly, disability is one of the most important benefits
an employer can offer to an employee because it provides income in those circumstances when
workers' compensation is either unavailable or insufficient. Short-term disability coverage is
required by law in several states; therefore, employers should check their states' requirements.
Disability benefits are subject to requirements of the Employee Retirement Income Security Act,
including the requirement that a summary plan description be furnished to employees.

Long-term Care Insurance

Recognizing that our society has changed to a point where individuals who require long-term care
can no longer expect to have family members able and available to care for them and that
Medicare benefits do not adequately fill the gap, an as-yet modest number of employers are
offering long-term care insurance benefits to employees.

Long-term care may mean nursing home care and/or care in the insured person's own home.
Although most long-term care is provided to seniors, the sad truth is that people of any age can
find themselves permanently or temporarily unable to care for themselves without help. Further,
applying for insurance at a relatively young age has its benefits, because most insurers base
future premiums on the age at which the insured first applied for coverage.

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In most cases, long-term care insurance benefits are unsubsidized; that is, employees are
expected to pay the full premium. However, access to group insurance may reduce the premiums
that employees pay. Employees are also likely to believe that they are benefiting from employer
research into the range and quality of benefits offered and the financial security of the insurer, so
employers should expect to do some ratings research and comparison shopping.

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Cafeteria Plans:

Introduction

A cafeteria plan is an employee benefit that is frequently misunderstood. Yet, for those that can
appreciate its advantages, the cafeteria plan has become a highly desirable employee benefit in
light of the recent changes in the economic and tax scene.

Although originally sanctioned by Congress in 1978, under Section 125 of the Internal Revenue
Code, cafeteria plans have only recently come into vogue, as companies look for ways to reduce
some of the expense of providing medical coverage for their employees. A cafeteria plan (also
called a “flex plan”) can save employees money, as well, by allowing them to purchase some of
their medical coverage (and other costs) with "pre-tax" dollars.

Flexible Benefit Plans

In a flexible compensation program a specified amount of pay is offered by an employer for the
purchase of employee benefits. An employee is provided with a number of benefit options which
can be selected.

An employer in such a plan defines its commitment in terms of its contributions to the benefit
program rather than in terms of a fixed program of benefits. This effectively creates compensation
that is visible to employees. Employees are permitted to select benefit programs that fit their
personal needs rather than being covered by a “common program.”

A flexible spending account is created for each participating employee. The account is a reserve
that is available to reimburse employees for certain expenses not covered under group insurance
programs. Such expenses include health care expenses, such as deductible or coinsurance
amounts, and work-related dependent-care expenses.

Flexible spending accounts can be an option under a broader flexible program, or they can be the
only element of flexibility in a benefit program. Deposits to the spending accounts are funded by
employer or employee contributions; the accounts supply funds that are available for
reimbursement of eligible expenses during the full plan year. Neither the amounts deposited nor
the amounts withdrawn by employees as reimbursement for eligible expenses are considered
taxable income.

Legal Restrictions:

Flex plans are subject to the following rules:

a.Amounts allocated to a flexible spending account must be used during the plan year or they
will be forfeited to the employer at the end of the year.

b.An employee must be able to obtain reimbursement for incurred expenses from deposits that
have been elected for the plan year but not yet made.

c.Contributions and benefits may not discriminate in favor of highly paid employees.

d.No more than 25 percent of the benefits under the plan may go to key employees;

e.Eligibility for plan participation may not discriminate in favor of highly paid employees. The
nondiscriminatory coverage rules for retirement plans can be used as a safe harbor for this
requirement.

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If the requirements outlined above are not met, income will be imputed for key employees or
highly paid employees.

Flexible Benefits Options

Flex plans can include choices in the following coverage:

Medical plans;
Vision, hearing and drug plans;
Employee life insurance;
Spouse or dependent life insurance;
Postretirement health benefits;
Accidental death and dismemberment insurance;
Universal life insurance;
Vacation time;
Dental plans;
Flexible health care spending accounts;
Flexible dependent care spending accounts; and
Retirement plans.

Reporting And Disclosure

The law requires that benefit plans be created and administered in accordance with a written plan
document that details certain information. The written plan document can incorporate by
reference the plan documents for any benefits that are provided to employees under separate
written plans. If the plans provide different maximum coverage levels, they must be specified.

Generally, the plan document provides a description of benefits, participation rules, election
procedures, employer contributions and the plan year.

There can be separate plan documents for a 401(k) plan and other programs such as accident
and health, dependent care, group legal services, etc.; separate plan documents are required for
health care and dependent care flexible spending accounts.

Annual Reports

The Internal Revenue Service and the Department of Labor require the filing an annual report
(Form 5500 series). The information in the annual report should also be summarized and made
available for plan participants.

NOTE: Small plans that have less than 100 participants and meet certain other rules are not
required to file annual reports.

Summary Plan Descriptions

A summary plan description (SPD) is a description of the flexible benefits plan, written in plain
English, and made available to participants and designated beneficiaries.

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401K Plans

Introduction

Although the 401(k) plan has been in existence for over two decades—since 1978 when
Congress Section 401(k) to the Internal Revenue Code—it has only recently become popular and
accepted as the retirement benefit of choice in many organizations. This type of plan is also
referred as a "cash or deferred arrangement" (CODA) because it gives employees a choice
between cash currently or deferring the amount and having it contributed to the plan. In addition,
many employers often match employee contributions, up to a certain percentage of salary. The
CODA has become one of the most popular forms of qualified plans among both large and small
employers. This section contains an overview of 401(k) plans—considerations, implementation,
design, maintenance, and compliance.

Overview:

A 401(k) plan permits employees to choose to defer a portion of their wages on a pretax basis.
The 401(k) plan must be part of a qualified profit-sharing plan, a stock bonus plan, a pre-ERISA
money pension plan, or a rural cooperative plan.

The ability of the employer to “match contributions” has generated interest in the plan at all
employee levels. This is important because 401(k) plans include strict nondiscrimination tests that
require lower paid employees to defer compensation under the plan, in proportion to highly paid
employees—in accordance with one of several formulas outlined below. The minimum level of
deferral for lower paid employees is determined under a statutory formula based on utilization of
the by highly compensated employees.

Features to the Employee

The major benefit to employees is that they are not taxed currently on the portion of
compensation that is placed in the plan. An employee has the option of choosing between cash or
future benefits on a year-to-year basis. This protects an employee when faced with unexpected
immediate financial needs.

A 401(k) plan is a qualified defined contribution plan. This means that an employee can elect to
defer allocations. The contributions enjoy tax-free reinvestment of earnings and the opportunity to
receive special tax treatment on certain plan distributions.

A 401(k) plan frequently features an “employer matching” provision in which the employer makes
a contribution to the plan equal to (a certain percentage of) the employee’s contribution. This
serves to encourage participation among employees at all levels.

Another major benefit—in addition to the tax deferral—is that a 401(k) plan is eligible for five-year
averaging on distributions. But, if an early distribution is taken, the amount is subject to an
additional 10 percent tax.

Benefits and Drawbacks

Benefits to the Employer

Strict discrimination rules affect the qualification of pension plans. These rules focus on highly
compensated employees and are described below. They require that a business stimulate as
much participation as possible, particularly from lower-level employees, in order to avoid violating
the rules and jeopardizing the qualification of the plan. A 401(k) plan:

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1.Is a valuable way of triggering participation by employees, since it permits pre-tax
contributions through salary reduction.
2.Can also help a business short on working capital remain competitive by making available a
CODA plan, and still structure it in a form whereby the employees pay all.
3.Permits a company to address employee demands for additional cash compensation without
added cost and without jeopardizing the retirement income security of employees.
4.Is also a good starting point before setting up other programs like cafeteria plans.

Drawbacks to a 401(k) Plan

1.A 401(k) plan’s features can taint the need for employees to provide for their retirement
because, under certain conditions, the money can be loaned or distributed in hardship
situations.
2.Such a plan should not be used in lieu of a thrift plan if its main purpose is to increase
short-term capital accumulation. A 401(k) plan is not designed for frequent withdrawals.
3.In an environment of primarily low-paid service employees, the attractiveness of a cash
deferral plan is minimal.
4.The record-keeping requirements are strict and costly.

Legal Requirements

Because a 401(k) plan is a qualified plan, it is subject to the same rules imposed by the Internal
Revenue Code and ERISA as are all other qualified plans. Therefore, it must be part of a definite
written plan that is communicated to employees and established solely for the benefit of
employees or their beneficiaries. A 401(k) plan must also meet these requirements:

Certain minimum funding rules;

One of two coverage tests:

a.The ratio percentage test (the percentage of the non-highly compensated employees, benefiting
under the CODA must be at least 70 percent of the percentage of highly
compensated employees benefiting under the CODA); or

b.The average benefits test (in addition to meeting a nondiscriminatory classification test,
described below, the average benefits provided by the employer for non-highly
compensated employees must be at least 70 percent of the average benefits provided
for the highly compensated employees). The minimum participation test (the plan must cover no
fewer than the lesser of 50 employees or 40 percent of all employees of the employer).

Eligibility restrictions (no employee who is otherwise eligible can be required to complete more
than one year of service as an eligibility requirement, even if 100 percent vested at all
times).
General nondiscrimination tests; and
General vesting rules.

A 401(k) plan is also subject to the restrictions on the amount of pay that may be taken into
account for contribution and benefits calculations. The pay limit is generally $150,000.

Only certain types of plans can include a 401(k) feature. But, in addition to satisfying specific
qualification requirements, a 401(k) plan must also meet certain participation rules, vesting rules,
benefit distribution rules, and accounting rules. In addition, certain general plan qualifications
requirements are applied in special ways to 401(k) plans. For example:

A plan may not condition participation on the completion of more than one year of service;

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To determine whether a plan complies with the minimum coverage requirements, all
employees eligible to participate in the plan are treated as if they were benefiting under the
arrangement; Elective contributions by employees to a 401(k) plan must be non-forfeitable from
the moment made; and Only amounts attributable to employee elective contributions (and other
employer contributions taken into account under the special 401(k) nondiscrimination tests) can
be distributed.

Plan Funding

There are several different types of contributions that can be permitted in a 401(k) plan. These
include:

Elective contributions. These are amounts a plan participant could have chosen to take in
cash but has instead opted to defer.

Non-elective contributions. Employer contributions (other than matching contributions) that are
automatically paid to the plan; the employee may not elect cash instead of the plan
contribution.

Qualified non-elective contributions. These are a subset of non-elective contributions

that:
a.Are immediately non-forfeitable; and
b.Are subject to Section 401(k) distribution restrictions; under those rules, the
contributions cannot be withdrawn for purposes of hardship.

Employee contributions. These are amounts contributed to the plan by an employee on a post-tax
basis.

Matching contributions. These are amounts made by an employer to a plan on account of

employee contributions or elective contributions.

Qualified matching contributions. These are subsets of matching contributions that are:
a.Immediately non-forfeitable; and
b.Subject to Section 401(k) distribution restrictions; under those rules, the contributions
cannot be withdrawn for purposes of hardship.

Contribution Limits

As explained earlier, CODAs are subject to restrictions on the amount of pay that may be taken
into account for contributions and benefits calculations. In addition, the amount of elective
deferrals that an employee may make annually, is limited to $10,500 in 2000 (increased from
$10,000 in 1999).

NOTE: All contributions for a taxable year must be counted in addressing an employee’s cap for
the year, even if made to plans sponsored by different employers (such as when jobs have been
changed during the year).

Non-elective Employer Contributions

Non-elective contributions under a 401(k) plan, including matching contributions, are not counted
in applying this annual dollar amount. These amounts are counted in applying the contribution
limit of the lesser of 25 percent of compensation or $30,000.

Reporting Elective Deferrals To Employees

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Employers must report, to their employees, the amount of elective deferrals made during
the year. This is done on Form W-2. The report must be filed on or before the due date for
providing the Form W-2.

Elective Deferrals In Excess Of The Allowable Amount

A participant is subject to taxes on elective deferrals in excess of the allowable dollar limit in a
taxable year. If the amount remains in the plan beyond April 15 of the year following the year of
the deferral, it will also be taxed upon its distribution from the plan. Thus the participant pays
taxes twice: in the year of the excess contribution, and in the year of distribution.

Elective deferrals in excess of the caps for a single employer require the employer to begin
withholding federal income tax. If a participant has made excess deferrals for a year, no later than
March 1 of the following year, he/she can allocate the excess deferral among the plans to which
they were made and notify each plan of the portion allocated to it. Each plan may then distribute
to the individual, no later than April 15, the amount of excess allocated to it (and any income on
that amount). Should the excess amount be distributed by the April 15 deadline, it will not be
taxed in the year it is distributed, but it will be taxed in the year that it would have been received
as salary, if not for the deferral.

A key benefit is that this procedure avoids the 10 percent additional tax on early distributions from
qualified plans. The amount of income allocable to the excess deferral is treated as received in
the year in which the excess deferral was made rather than in the year distributed. But the excess
deferrals distributed by April 15 are counted in the actual deferral percentages in applying the
nondiscrimination tests, regardless of the distribution from the plan.

Interaction With Other Plans

A 401(k) plan linked to a thrift or savings plan involves the deferral, throughout the year, of
amounts employees would have otherwise received as taxable salary or wages. This has given
such an arrangement the more common notation as a “salary reduction plan.” It is financed by a
cut in immediate cash pay received versus eating into a year-end cash bonus.

This type of arrangement is not founded upon the employer’s making any additional contributions.
Rather, employees are given the option to forsake their current pay, subject to a minimum and
maximum amount, as stipulated in the plan. The employer then contributes a dollar amount
equivalent to the pay reduction to the plan. The money represents an immediate tax savings that
accumulates in the plan tax-free until it is withdrawn.

Nondiscrimination Rules

A 401(k) plan must meet certain nondiscrimination tests to ensure that highly compensated
employees cannot elect to defer a disproportionately higher amount of their salary than the
non-highly compensated employees are deferring. If the 401(k) plan does not meet these special
nondiscrimination requirements, it may be disqualified.

Nondiscrimination testing applies separately to non-elective contributions, elective contributions,

employer matching and employee after–tax contributions.

Non-elective contributions must satisfy the nondiscrimination standards set forth in Section 401(a)
(4) of the Internal Revenue Code.

Elective contributions must satisfy one of the limit tests set forth in Section 401(k)(3)(a)(ii) of the
Code. For the purpose of meeting the actual deferral percentage test, all or part of the qualified
non-elective contributions and qualified matching contributions may be treated as elective
contributions.

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NOTE: Disqualification can be prevented if the contributions in excess of the limitation are
distributed to the contributing employees or are re-characterized as after–tax contributions.

Highly Compensated Employees

A qualified plan cannot discriminate in favor of highly compensated employees (HCEs). An HCE
is any individual, who during the year or the preceding year:
Was a 5 percent owner of the employer; or
Received annual compensation in excess of the amount designated by the Internal Revenue
Code (IRC), and (if so elected by the employer) ranked in the top 20% of employees (by
compensation) in the prior year.

NOTE: The Small Business Job Protection Act of 1996 initially set the "excess compensation"
amount at $80,000, for years beginning after 1996. The Treasury department indexes (adjusts)
this amount for inflation annually. Thus the amount in 2000 is $85,000

Hardship Withdrawal Rules

One of the benefits of a 401(k) plan versus other plans is the ability to make a hardship
withdrawal under specific circumstances. Generally, employees who want to access their 401(k)
savings must: “Quit their jobs and pay an excise tax for early distribution; or (if the plan allows),
Show severe financial hardship and pay the excise tax penalty; or Borrow from their 401(k)
savings and pay their account’s interest on the borrowed amount”.

NOTE: Employees who fail to repay the loan before terminating employment will be liable for the
excise tax plus ordinary income tax on the outstanding loan amount.

These withdrawals are generally permitted only if the employee has immediate and necessary
needs for additional finances. Examples of the kinds of expenses that qualify are:

Outlays related to the purchase of an employee’s principal residence (but not mortgage
payments); Tuition and education related fees for the next 12 months of post-secondary
education for an employee, the employee’s spouse or dependents; Medical expenses for the
employee, spouse or dependent of the employee; Outlays needed to prevent eviction of the
employee from the principal residence or foreclosure of a mortgage on the principal residence; or
Expenses due to the death of a family member.

The distribution must also be “necessary.” The employee must show that based on the facts and
circumstances, there are no other available resources, including loans, to meet the need.

For example, an employer may deem a distribution as necessary if the employee certifies and
there is no reason to believe to the contrary, that money isn’t available through:

Liquidating other assets, without posing additional harm;

Ceasing elective and employee contributions;
Insurance;
Other distributions or nontaxable loans from plans maintained by the employer; or
Borrowing from commercial sources on reasonable terms.

NOTE: Assets of the participant, the spouse and even the children, if reasonably available, are to
be taken into account. The determination of hardship must be made on the basis of
nondiscriminatory and objective standards contained within the plan documents.

Funds Available for a Hardship Withdrawal

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A hardship distribution is limited to an employee’s total elective contributions as of the date of
distribution, reduced by any amounts previously taken for hardship. A plan can also provide for
amounts from the end of the last plan year ending before July 1, 1989. These include amounts
from:

Income on elective contributions;

Amounts treated as elective contributions; and
Income allocable to amounts treated as elective contributions.

Tax Consequences of Withdrawals

Hardship withdrawals are subject to normal taxation of plan distributions and may be subject to a
10 percent tax for premature withdrawals. This additional tax can be avoided only if the
distribution is made after the employee has reached age 59 1/2, if the distribution is made in
periodic payments, or if the hardship involves medical expenses and the distribution does not
exceed the deductible medical expenses.

Plan Loans

A 401(k) plan can also make funds available to participants by loan in a broader way since a loan
is not subject to the “hardship rules.” Specifically, 401(k) plans can lend a participant:

Up to the lesser of 1/2 of the participant’s vested account balance or $50,000; and
Up to $10,000 regardless of the limits described above.

Loan vs. Hardship Withdrawal.

Loans are not taxable to the employee provided the loan repayments are made when they are
due.

A loan option, however, places additional administrative work on the employer. The loan
agreements may not be discriminatory. And, the employer has the additional burden of dealing
with defaults.

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Fringe Benefits & Executive Perks

Introduction

Businesses have traditionally offered employees an array of benefits that fall beyond pensions
and deferred compensation arrangements. This section will discusses a number of these non-
statutory (voluntary) fringe benefits.

Non-statutory fringe benefits (also referred to as perquisites or “perks”) are often restricted in
general use to executives. These benefits offer no particular tax advantage to either the company
or the executive. As with any other form of compensation, perks are generally taxable to the
employee, and are deductible as a compensation expense to the company.

However, some fringe benefits may be tax-free to the employee, such as business expense
accounts, no-additional-cost services, qualified employee discounts, working condition fringes, de
minimis fringes, qualified transportation fringes, or qualified moving expense reimbursements.

Personal Days, Holidays and Religious Leave

Businesses offer employees paid time off for a number of holidays during the year. Few states
regulate this time-off benefit. It has become a commonly expected norm. The actual number of
holidays and days allowed away from work vary, often depending on specific industry practices
and the size of the workforce.

In addition, employers allow workers days off to take care of non-company business that they
cannot take care of outside of regular working hours. These are normally referred to as “personal
days.”

Employers also grant employees time-off to attend religious obligations. Some members of the
work force follow religious practices that require them to be absent from work on particular days.
Employers are obligated by federal law to provide reasonable accommodation for these religious
needs.

Vacation Pay

Salary and wages paid for vacations, holidays or special days off, such as birthdays, are taxed to
the employee as though they were working on those days. And, the costs of these payments
remain deductible to the employer.

NOTE: The IRS has ruled that amounts paid to an employee under a plan that allows employees
who suffer medical emergencies to receive additional leave—surrendered to the employer by
other employees or deposited by its employees in an employer-sponsored leave bank—are gross
income to the employee who receives the leave.

Similarly, if an employer provides or pays the expenses for an employee’s vacation, the employee
will recognize compensation regardless of whether it is provided as a reward for extraordinary
performance or for other motivational reasons.

Flexible Hours

The demands of the current work environment and shifting demographics have required
companies to actively consider alternative work schedules. Severe competition has also made
the recruitment and retention of qualified employees important.

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Many service industries such as food, banking and the accounting profession, have offered
flexible work schedules. With the influx of women into the workforce over the past two decades
and the subsequent need for “family friendly” policies, more firms are turning to flexible hours as
an option.

While not appropriate for every type of business, flextime and other alternative work schedules
have helped employees balance their work and family responsibilities and maintain productivity
standards.

Tax Issues

In general, a fringe benefit is taxable to the employee unless there is a specific provision in the
Internal Revenue Code that allows for nontaxable treatment. Fringe benefits without their own
statutory exclusion may be nontaxable, if they fit into one of six categories:

1.No-additional-cost services;
2.Qualified employee discounts;
3.Working condition fringes;
4.De minimis fringes;
5.Qualified transportation benefits; and
6.Qualified moving expense reimbursements.

No-Additional-Cost Services

A no-additional-cost service fringe benefit is a service provided by an employer to an employee,

the employee’s spouse or dependent at no charge, at a reduced price or a with a total or partial
rebate of the amount charged. This preferential tax treatment generally applies only to services,
not goods.

The receipt of these services is excludable from an employee’s income if the service is provided
without discrimination with regard to availability as to officers, owners and highly compensated
employees. In addition, the following two requirements must be met:

1.The fringe benefit must be a service that is offered for sale to customers in the ordinary
course of business of the employer; and
2.Providing such service must not cause the employer to incur a substantial extra cost.

A typical example of a no-additional-cost service would be an airline allowing its employee to fly
for free (in an otherwise empty seat). In that case, an additional benefit (such as an in-flight meal)
that is incidental to the benefit actually provided (the airfare), is also allowed.

Working Condition Fringes

A working condition fringe benefit is any service or property that an employee would be entitled to
take a deduction for as a business expense or as depreciation had he paid for the item.

Examples
Examples of working condition fringe benefits are:

A company car provided for an employee who must travel from customer to customer on
business; Expenses associated with an employee’s office decor; Home computers; and
Services, such as properly structured outplacement services offered to laid off employees.

Unlike other non-statutory fringe benefits, the anti-discrimination rules do not apply to working
condition fringe benefits.

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Qualified Employee Discounts

A qualified employee discount is a discount offered by the employer to his employees with
respect to property or services for the personal use of the employee and his dependents. For a
qualified employee discount to be excludable from an employee’s income, the discount must be
a discount on services or property offered to customers in the ordinary course of the business in
which the employee is engaged. The discount may not exceed 20% of the price at which the
services are being offered to customers.

If the discount is on property, it may not exceed the employer’s gross profit percentage of the
price at which the property is being offered to customers. In addition, qualified employee
discounts may not be provided on real estate or investment property. Finally, as in the case of
most benefits, the discount may not discriminate in favor of highly compensated employees.

De Minimis Fringes

A de minimis fringe benefit is a benefit that has a value so small that accounting for it is
impractical. For example, a common de minimis fringe benefit is a company cafeteria located on
or near the employer’s business premises, where the cost of the meals paid by employees
covers the direct cost of running the cafeteria. Executive dining rooms do not qualify, since the
de minimis fringe benefit of employer-provided eating facilities may not be provided on a
discriminatory basis to highly compensated employees.

NOTE: The anti-discrimination provisions do not apply to the provision of de minimis fringe
benefits, other than eating facilities.

A de minimis benefit may only be provided on an infrequent basis. Frequency is determined by an

employer perspective, if it is administratively difficult for the employer to determine the frequency
of a particular employee usage. Thus, even if an employee frequently uses the company
cafeteria, he generally is considered in receipt of a nontaxable de minimis fringe benefit.
However, an individual membership in a private country club or athletic facility, regardless of the
frequency with which the employee uses the facility, is not a de minimis fringe benefit.

A de minimis fringe benefit can include employee prizes and service awards. However, cash and
cash equivalent fringe benefits can never qualify as a de minimis fringe benefit.

Club Dues

A company may pay for the membership of a key employee in a private eating or country club.
This perk is also more common in closely held companies because of the common practice of
having the company cover the owner-employee’s living expenses.

NOTE: Club dues paid or incurred after 1993 are no longer deductible. Under prior law, club dues
were deductible under certain conditions. But, specific business expenses, such as for meals,
that are incurred at a club eatery—as anywhere else—are still deductible, to the extent (50%) any
business meals and entertainment are currently deductible.

Below-Market Loans

The forgiven interest on low-interest or interest-free loans will be considered taxable income to an
employee/borrower for loans from employers over $10,000.

Company Cars

Company cars are those owned by the employer but used by the employee. An employee’s
personal use of the car is taxable income to the employee, unless the employee reimburses the

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company for that expense. Reimbursement for private use is more common in public companies
than in closely-held companies.

Qualified Transportation Fringe Benefits

Qualified transportation fringe benefits include:

1.Transportation to and from work in a “commuter highway vehicle” (basically a bus or van);
2.A transit pass; or
3.Qualified parking.

Qualified parking includes parking at or near the employer’s business location, or at or near a
location where the employee can commute to work by a commuter highway vehicle provided by
the employer. The allowable benefit level for qualified parking is $175 per month.

Mass transit subsidies.

Mass transit subsidies (transportation by commuter highway vehicle or transit passes) are
permitted up to $65 per month.

Commuting expenses.
Commuting expenses are generally taxable. Thus, the value of a car and driver usually will be
imputed to an executive as income.

Miscellaneous Executive Perks

Some examples of taxable fringe benefit perks:

Executive Dining Rooms

These are provided as a method of increasing the executive’s productivity by decreasing the
time needed to eat. The value of the meal is taxable to the executive.
Expense Accounts
An expense account is usually provided for an executive as a means of paying for business
expenses. Use of such an account for personal expenses will result in taxable income to the
extent of the personal use.

Financial Counseling
Many corporations provide assistance to executives in structuring their financial affairs in
order to free the executives from concerns that might distract them from doing their job. Lodging
on Company Premises Unless required for the convenience of the employer, the provision of
lodging on company premises is considered a personal expense of the employee.

Free or Reduced Cost Parking

Free or reduced cost parking generally is considered a qualified transportation fringe benefit
and, thus, is not includable in an employee’s gross income except to the extent that the value
of such parking exceeds $175.

Home Security Services

Because of the threat of kidnappings and other crimes, some corporations are providing home
security services for high-level executives. The value of such services generally is considered
a taxable personal expense.

Athletic Facilities
The value of the use or availability of an on-site athletic facilities may be excluded from an
employee’s compensation. Athletic facilities are somewhat peculiar in the eyes of the tax law, in
that the anti-discrimination provisions which otherwise apply to fringe benefits under the tax
code do not apply to employer provided athletic facilities.

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-48-
Employee Termination

Introduction

Employers should be familiar not only with issues concerning employee benefits during the period
of employment, but also what former employees and their beneficiaries are entitled to upon,
termination, or death. Moreover, employers must convey this information to employees, former
employees and their beneficiaries.

Employers should establish a program in which employees, former employees and beneficiaries
are educated about the benefits available to them upon retirement, termination, or death.

An employee is faced with several important decisions affecting both the financial and tax
consequences of the distribution of his/her benefits. In order to provide an employee with a basic
outline of options, it is important to review the various choices available.

Generally, distributions are taxable as ordinary income under the same rules used in the tax laws
for payments of annuity contracts. However, the tax consequences will be different to a plan
participant if he/she chooses to take the distribution in a lump-sum. There are also different
consequences if employer securities are involved. Moreover, beneficiaries often are entitled to a
$5,000 exclusion for certain death benefits. Also, in lieu of paying taxes on the distribution, a
participant or beneficiary may be entitled to roll over the distribution to another plan or an IRA.

Pre-Retirement Programs

Pre-retirement programs offered by some organizations to employees age 55 and older are
designed to help them cope with the financial and psychological changes that take place in
retirement.

Employees may be given financial data to complete to give them a picture of what their financial
position will be at retirement. Pre-retirement saving may be encouraged and income and estate
tax considerations outlined. Some instruction also may be offered on changing relationships,
second career possibilities, etc.

Group-Term Life Insurance

A common goal of life insurance—especially for younger workers—is to create what may be
characterized as an “instant estate” for an insured who dies prematurely, before having had an
opportunity to build an estate.

A retiree’s need for insurance does not conform to that proposition—if he has reached the normal
retirement age of 65, his subsequent death cannot readily be viewed as premature or as coming
before he has had an opportunity to build an estate.

This being so, neither the retiree nor the retiree’s former employer ordinarily will see any pressing
need for continuing coverage of the retiree under a group-term policy. If obligated to pay the
sharply escalating premiums as the retiree continues to age, the employer may experience a
pressing need to discontinue coverage.

The employer will generally not want to offer retirees continued group-term coverage, except as it
may be bound by an enforceable contractual obligation, either a union contract or an individual
employment contract. However, there may be special circumstances under which the employer
may want to provide long-term coverage to certain individuals, such as where the business is a
family corporation and the retiree is a family member or has had long service with the business,
or possibly where the retiree does not have long to live.

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The individual retiree who needs or wants the planning benefits that life insurance offers may
want to take advantage of the privilege that most group-term policies offer, i.e. conversion to
permanent life insurance at level premiums. Permanent life insurance offers tax-free buildup of
cash value, conversion to an annuity, if that is thought to be desirable, and exclusion from estate
and income taxation of the proceeds if the requirements of the Code are observed.

NOTE: If the employer pays the premiums for continuation of coverage, it will be entitled to
deduct those costs as a usual business expense. This is a benefit that should not be overlooked.

Beyond the possible tax benefits, there are other ways an employer can limit the cost of
continuation insurance, including:

Getting some form of contribution for premiums from the retiree;

Limiting coverage to some specified age;
Using some form of decreasing term ending at a specified age; and
Treating the employer premiums payments or some part of them as loans, with or without
interest, and repayable out of the insurance proceeds.

Split-Dollar Life Insurance

Split-dollar insurance is sometimes thought of as a means of providing executives with life

insurance protection at low cost. Split-dollar might be considered as a possible alternative to
group-term for non-executive retirees, as well.

Some policies are offered on terms that permit the cessation of premium payments after eight
years, for example. This could be helpful to the retiree. In addition, split-dollar, unlike group-term,
will provide the retiree with cash value. For more on split-dollar and other insurance
arrangements.

Medical Benefits

Retiree medical benefits are a matter of great concern to both employers and employees. For the
employer who is committed to providing such benefits, rising costs cause concern. Cost are rising
as people are living longer.

The first action the employer will want to take is to review its commitment to the employee. One
major concern is whether it is binding or not. For example, if the agreement is found in a union
contract, and is clearly found to be in force, then an obligation exists—versus something that may
be interpreted to be implied in a manual.

It has been held that the plan description (SPD) required by ERISA and distributed to employees
controls. If the SPD reserves the right of the employer to alter, modify, or eliminate the plan—
which many do—this may override any implied promise of lifetime or no-cost medical benefits
contained in an employee manual or brochure.

Care should be taken to review terms used in manuals or brochures to make sure that the
intention of the employer is being properly communicated. If promises are made, their binding
nature could be costly.

Each employer should make a cost-benefit analysis in terms of its own workforce, age categories,
turnover rate, health state, and all other factors bearing on the present and future costs. On the
benefit side, the employer will want to consider what is being offered by competitors tapping the
same labor pool and what effect this will have on recruitment and retention of talent.

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COBRA Continuation of Health Care Benefits

Federal law requires most employers with group health plans to offer employees and their
spouses and dependents a temporary period of continued health care coverage if their employer-
provided coverage should cease. These continuation requirements are commonly referred to as
COBRA (the Consolidated Omnibus Budget Reconciliation Act of 1985). In general, employers
must offer coverage for a period of up to:

18 months for covered employees, as well as their spouses and dependents, when health plan
coverage is lost due to termination or a reduction of hours.
36 months for spouses and dependents who lose coverage due to divorce or legal separation, the
employee's death, or another specified "qualifying event."

COBRA requires that most employers sponsoring group health plans offer employees and their
families the opportunity for a temporary extension of health coverage (called continuation
coverage) in certain instances where coverage under the employee’s plan would otherwise end.

Several events that can cause workers and their family members to lose group health coverage
may result in the right to COBRA coverage. These include

voluntary or involuntary termination of the employee’s employment for reasons other than
“gross misconduct”; reduced hours of work for the employee; eligibility for Medicare coverage for
the employee; divorce or legal separation of a covered employee; death of a covered employee;
or loss of status as a “dependent child” under plan rules.

Under COBRA, the affected employee or family member may qualify to keep their group health
plan benefits for a set period of time, depending on the reason for losing the health coverage. The
following represents a basic overview of some basic information on periods of continuation
coverage:

Under COBRA, the affected employee or family member may qualify to keep their
group health plan benefits for a set period of time, depending on the reason for losing
the health coverage. The following represents a basic overview of some basic
information on periods of continuation coverage:

Beneficiary Qualifying Event Period of Coverage

Employee, Spouse, Termination Reduced 18* Months
Dependent Child hours
Spouse, Dependent Employee entitled to 36 Months
child Medicare,
Divorce or legal
separation,
Death of covered
employee
Dependent child Loss of dependent 36 Months
status

*This 18-month period may be extended for all qualified beneficiaries if certain conditions are met
in cases where a qualified beneficiary is determined to be disabled under COBRA.

Even when an employer does not pay the cost of health benefits following retirement, COBRA
requires that employers must provide certain employees, spouses, and their dependents with the
right to elect to continue coverage under a group health plan following certain “qualifying” events.

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NOTE: COBRA also provides that your continuation coverage may be cut short in certain cases.

Of all the federal legislation relating to employer-sponsored health care plans, COBRA imposes
the most significant administrative burden. Under COBRA, all employers (with few exceptions)
that provide medical insurance are required to make continuation of coverage available to plan
participants who would otherwise lose coverage. Individuals who elect COBRA coverage are
typically entitled to receive it for eighteen months to three years, depending on the reason
coverage was initially lost, unless they obtain other insurance during that period.

COBRA Premiums

Employers may charge COBRA beneficiaries a premium for continuation coverage of not more
than 102 percent of the cost of the coverage to the plan (150 percent in the case of certain
disabled employees). The amount over 100 percent is intended to partially defray the employer's
administrative expenses.

Who Must Provide COBRA Coverage?

COBRA’s provisions apply to all employers, except churches, and employers that normally
employ fewer than twenty employees on a typical business day during the preceding calendar
year.

To determine whether it qualifies for the small-business exemption under the law, an employer
needs to review the number of its employees during the previous calendar year. If fewer than
twenty employees worked on at least 50 percent of the working days, the employer is exempt
from COBRA’s provisions. In counting the number of employees, employers should include all
employees regardless of whether they are covered by the health plan, plus partners, agents,
independent contractors, and long-term temporary workers to the extent such individuals are
eligible to participate in the employer’s health plan.

COBRA considers groups of companies, such as subsidiaries and parent companies, to be a

single employer. Thus, a small (e.g., fifteen-employee) subsidiary of a larger company would still
be subject to COBRA’s provisions. However, small employers that obtain health benefits through
multiple-employer trusts or multiple-employer welfare arrangements (MEWAs) are each treated
as a single employer, enabling them to qualify for the fewer-than-twenty employees exemption
despite the size of the MEWA.

This applies to all employer-provided health benefits, including salary reduction health benefits,
unless provided by a small employer (generally, one with fewer than 20 employees), a
governmental plan or a church plan. Similar provisions apply to state and local governmental
plans.

What Plans Are Included?

COBRA applies to any employer-sponsored plan that provides medical care to employees, former
employees, or the families of employees or former employees. COBRA’s applicability to different
types of health plans commonly sponsored by employers is as follows:

Employee-pay-all plans. Generally speaking, an employee-pay-all health plan (i.e., one to

which the employer makes no contribution) is subject to COBRA if employees cannot
otherwise purchase coverage at the same cost—unless the plan is maintained by a union and
there is no employer involvement.

Wellness and disability plans. Wellness and disability plans are not generally subject to
COBRA. A program that “furthers general good health but does not relate to the relief or

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alleviation of health or medical problems and is generally accessible to and used by
employees without regard to their physical condition or state of health” is not considered a
medical care plan under COBRA. Employee assistance programs. COBRA does not apply to
counseling programs that would apply to in programs as would be the case for alcoholism and
drug programs. If an EAP also offers counseling for financial and legal problems, COBRA’s
jurisdiction is somewhat ambiguous. Arguably, COBRA should apply only to the medical facilities
both available and actually used under the EAP, but the law is not precise on this issue.

Cafeteria plans. If health care benefits are provided as part of a flexible benefits plan, COBRA
applies only to the medical benefits the covered employee has actually chosen to
receive, if any.

Planning For Retirement Distributions

There are three main objectives in planning for required minimum retirement distributions:

1.Avoiding penalties;
2.Deferring income tax; and
3.Satisfying liquidity needs.

Planning decisions must generally be made before the individual reaches age 70 1/2.

An individual should take no more than is needed to meet current liquidity needs.

To avoid penalties, distributions should generally begin not earlier than age 59 1/2 and not later
than age 70 1/2. They should also not exceed the excess distribution limit.

The deferral of income taxation is, obviously, a major objective in planning the timing and
amount(s) of distribution(s).

If an individual desires to wait until age 70 1/2 to begin distributions, there is little flexibility in the
required amount.

Avoiding The Excess Distributions Tax

Potential exposure to the 15 percent excess distributions tax described in this section, is a
particular problem for those at or near age 70 1/2, because there is limited flexibility in
determining the required distribution after that age.

To avoid this problem,some individuals that have not reached the required age will want to
consider taking their distributions early. While these distributions do not directly reduce the
required distributions after age 70 1/2, they do reduce the account balance used to determine the
required minimum distribution. This indirectly reduces the annual required distribution.

NOTE: Distributions before age 59 1/2 may be subject to the 10 percent early distribution tax.

Excess accumulated balances in qualified plans and IRAs are subject to a 15 percent tax at the
individual’s death. In general, excess accumulated balances are amounts exceeding the present
value of a single life annuity with annual payments of the greater of $150,000 or $112,500
(adjusted for cost-of-living increases) over the life expectancy of the decedent immediately before
his death. Distributions From IRA’s and Qualified Plans

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Planning for distributions from qualified plans and IRAs requires careful consideration of various
factors, including:

The tax rates at distribution;

The after-tax rate of earnings both inside and outside the IRA or plan; and
The age and health of the employee, IRA owner or beneficiary(ies).

Sources of Income

Some of the sources of replacement income are from government- mandated programs, such as
social security and workers compensation. But, particularly for the more highly compensated, a
more important source of replacement income is employer-sponsored private plans. Death
benefits can be provided under group life insurance plans, under pension, profit sharing, or thrift
plans, and under various other arrangements.

One of the more frequent failings when designing an employee benefit plan (e.g. a group life
plan) is not taking into account the magnitude of benefits payable under other employer-
sponsored and government-mandated plans with respect to the same contingency— in this case,
death. The result can be expensive benefit overlap.

Distributions At Death

Comprehensive benefit planning requires the proper communication of what replacement income
dependents will receive upon an employee’s premature death. While an employee is active, the
emphasis is on the replacement income needs of the family unit. Beginning at retirement, the
typical concern of the plan is for the needs of a surviving spouse.

Tax Consequences

In general, the recipient of a distribution from a qualified plan after the death of the participant is
taxed in the same manner as if the beneficiary were the participant. The annuity rules continue to
apply in the case of annuity distributions to the beneficiary.

Legal and Financial Considerations

When an employee is terminated, a number of sensitive legal and financial issues need to be
handled with care. When an employee changes jobs, there are some similar and some different
issues to be addressed.

Planning for retirement involves tax, legal, social socio-economic and other personal
considerations in deciding the best method for drawing on retirement funds. The employee must
focus on immediate cash needs, as well as future retirement and estate planning goals.

The death of an employee places a cross-section of concerns on the employer and the
beneficiaries of the employee. Unfortunately, most companies have few resources in place to
help guide survivors through the maze of decisions. Most companies do not set up a vehicle to
extend support to dependents of deceased employees and are reluctant to provide legal advice.
Usually, the only investment advice that the beneficiaries receive comes from stock brokers or
insurance agents, who may not always be objective. Surviving spouses frequently are
overwhelmed by the myriad decisions they must make at this most trying time.

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