Congress's HEART Act Is Benefits Headache

(Published July 10, 2008)

 

The Heroes Earnings Assistance and Relief Tax Act of 2008 (P.L. 110-245), dubbed the HEART Act, provides benefits preferences to employees who are in the National Guard and Reserves. It will also impact your 401(k) plan and, if you have them, health flexible spending accounts (FSAs).

 

Ten 'Hut

The tax code has long contained preferences for employees who leave employment to serve in the military. In addition, the Uniformed Services Employment and Reemployment Rights Act (USERRA) requires that plans not discriminate against employees who leave for military service. The HEART Act supplements these two laws.

 

Make-up contributions. Employees returning from military service must be allowed to contribute pre-tax make-up contributions into their 401(k) accounts. Special rules also apply to employer matching contributions and employee after-tax contributions. Under the HEART Act, for years beginning after December 31, 2008, military differential pay — the difference between employees' regular pay and military pay — must be treated as wages for these pre-tax make-up contributions, employer matching contributions, and employees' after-tax contributions. Note: Employers aren't required to pay military differential pay. Plans must be amended no later than the last day of the first plan year beginning on or after January 1, 2010.

 

Distributions on account of severance of employment. Normally, employees can't take in-service distributions from their 401(k) plans. Under the HEART Act, employees who are called to active military service for a period exceeding 30 days are considered severed from employment. Employees, therefore, may receive distributions of their pre-tax amounts. Watch out: Employees who take distributions can't make any contributions into the plan during the six-month period beginning on the distribution date. This provision is effective for distributions beginning after December 31, 2008.

 

Qualified reservist distributions. The 2006 Pension Protection Act allowed employees who are called to active military service for 180 days or longer, or for an indefinite time, to take penalty-free qualified reservist distributions from their 401(k) plans. The distributions must be made during the period that begins on the date employees receive their orders or call to duty and ends at the close of their active military service. However, this provision applied to individuals ordered or called to active duty after September 11, 2001, and before December 31, 2007. The HEART Act makes this provision permanent.

 

Survivor benefits and disability retirement benefits. The HEART Act adds new mandatory tax qualification requirements for 401(k) and other plans. Under the new requirement, plans can't discriminate in paying survivor benefits. If, for example, a plan accelerates vesting, ancillary life insurance benefits, or other survivor benefits that are payable upon an employee's death, those same benefits must be available to survivors when employees die during military service. Plans must be amended on or before the last day of the plan year beginning on or after January 1, 2010.

 

In addition, for benefits accrual purposes, the HEART Act allows (but doesn't require) a retirement plan to treat employees who leave for military service, and who can't be reemployed because they die or become disabled, as if they had been rehired on the day before death or disability (a "deemed rehired employee"), and then had terminated on the date of death or disability.

 

For deemed rehired employees, plans may fully or partially comply with USERRA's retroactive benefits accrual rules. Caveats: All employees who die or become disabled must be considered deemed rehired employees. Thus, the amount of benefits that is credited may differ for employees who earned different salaries, but plans can't limit deemed reemployment status to highly-compensated employees, for example. Moreover, for benefits that are contingent on employees' contributions, plans must determine the rate of employees' contributions on the basis of their actual average contributions made during the 12-month period before their military service began. The deemed rehired employee provision applies to cases of death or disability occurring on or after January 1, 2007.

 

Distributions from health flexible spending accounts. Cafeteria plans or health FSAs may make qualified reservist distributions of all or a portion of employees' FSA balances. Employees must be called to active military duty for at least 180 days (or for an indefinite period), and distributions must be made during the period beginning with the active-duty call and ending on the last day of the FSA's coverage period that includes the date of the active-duty call. This provision will help employees avoid the FSA use-it-or-lose-it rule. This provision is effective June 17, 2008.

 

Mental health parity. The Mental Health Parity Act (MHPA) requires that annual or lifetime dollar limits on mental health benefits be no lower than the dollar limits for medical and surgical benefits offered by a group health plan. It applies to group health plans (or health insurance coverage offered by issuers in connection with group health plans) that provide both medical/surgical benefits and mental health benefits. The MHPA had expired on December 31, 2007. The HEART Act extends the expiration date to December 31, 2008, but makes no substantive changes to the MHPA.

 

Related Topic(s): Benefits/Flexible Benefits, Leave/USERRA - Uniformed Services Employment and Reemployment Rights Act