1. Rewarding Employee Choice Rodney Drenkow, JD, MBA March 24, 2016

2. Agenda 1.403(b) plans 2.Definition of types of plans Opt Out Plan Rewards Plan Flex Credit Plan 3.Impact on: Income tax under the tax code “Affordability” under the Affordable Cafe Act IPERS covered wages 4.Compliance Issues 5.Plan design suggestions

3. Questions We will be at booth #73 at the IASBO Conference in Ames on March 30 th if you have any questions or would like to discuss any unique circumstances. Or you can call Fawn at 1-800-383-1623 if you have any immediate questions.

5. Assumptions We will use these assumptions for all of our examples (unless otherwise noted):  The employee’s name is “Ted”  Ted’s W-2 Compensation is $2,000/month  The premium for the lowest cost, self-only minimum value coverage available to Ted is $500/month  If Ted elects this coverage, he is required to contribute $175/month toward the cost of the coverage

6. Affordability To be “affordable” Ted’s contribution for the: Lowest cost self-only coverage available to Ted That provides Minimum Value (pays at least 60% of medical expenses determined actuarially) Must be less than 9.56% (for 2015) of Ted’s household income Using 9.5% of W-2 Compensation is a “safe harbor” Example: Ted’s contribution for coverage:$175/month $175 ÷ $2,000 = 8.75% AFFORDABLE If not “affordable” and Ted waives coverage and receives subsidized coverage on the Public Marketplace, the school district must pay a $3,000 (as indexed) penalty tax for Ted.

7. Affordability PLEASE NOTE: It makes no difference what coverage Ted actually elects. Ted’s “cost of coverage” is the amount that will be entered for Ted on Line 15 of Form 1095-C

8. 403(b) Plan

9. EXAMPLE 1: If Ted waives all major medical coverage, the school district makes a $150/month contribution to Ted’s 403(b) plan. EXAMPLE 2: The school district lets Ted choose between Coverage A and Coverage B. If Ted chooses Coverage B (which has a smaller premium) the school district makes a $150/month contribution to Ted’s 403(b) plan. Neither example is permitted under the Tax Code. The next slide shows how to do this properly.

10. 403(b) Plan EXAMPLE 3: Same as above except that the reward is $150/month in cash rather than a deposit to Ted’s 403(b) plan. Ted voluntarily deposits the $150/month into his 403(b) account. This is permitted if the school district has a “cash out” option in its cafeteria plan document. Ted must have an effective option to keep the cash. Income tax, ACA and IPERS implications will depend on whether this is an “opt out” plan or a “rewards/flex credit” plan.

11. Opt Out Plan

12. EXAMPLE 4: Cash Only If Ted “opts out” (waives all major medical coverage) Ted is paid $150/month additional taxable compensation.

13. Opt Out Plan Income Tax- If Ted waives coverage and receives the cash, $150 is subject to Federal & State income tax withholding and FICA, Medicare and FUTA tax ACA Affordability- $150 is added to Ted’s cost of coverage even if Ted does not take the cash. Ted’s contribution for coverage:$175/month Amounts Ted received or could have received:$150/month Cost of Ted’s Coverage:$325/month $325 ÷ $2,000 = 16.25% NOT AFFORDABLE IPERS- $150 is IPERS covered wages even if Ted does not take the cash (subject to the exception on the next slide).

14. Special IPERS Exception for Dual Coverage If Ted is permitted to waive coverage ONLY if he has other major medical insurance (dual coverage): The amount that Ted receives in cash is NOT IPERS covered wages if Ted can prove that he has coverage under another health care plan. IAC 495-6.5(6). If Ted’s ability to waive coverage and receive cash is unrestricted, then this exception does not apply.

15. Opt Out Plan EXAMPLE 5: Cash and/or Pre-Tax Benefits Ted can elect to receive the $150 Opt Out amount in cash or use it toward the cost of one or more of the following benefits: Dental, Vision or Group Term Life Insurance Health Flexible Spending Account All amounts are considered “employee” contributions and will count toward the annual $2,550 contribution limit Dependent Care Account Deposit to a Health Savings Account (if otherwise eligible)

16. Opt Out Plan Income Tax- Any amount taken in cash is subject to Federal & State income tax withholding and FICA, Medicare and FUTA tax Any amount used to pay for any of the other benefits, it is NOT subject to any of the above taxes ACA Affordability- $150 is added to Ted’s cost of coverage even if Ted does not take the cash. Ted’s contribution for coverage:$175/month Amounts Ted received or could have received:$150/month Cost of Ted’s Coverage:$325/month $325 ÷ $2,000 = 16.25% NOT AFFORDABLE IPERS- $150 is IPERS covered wages even if Ted does not take the cash (subject to the dual coverage exception).

17. Opt Out Plan EXAMPLE 6: Pre-tax Benefits Only – No Cash Ted can ONLY use the $150 Opt Out amount for one or more of the following pre-tax benefits (no cash out option): Dental, Vision or Group Term Life Insurance Health Flexible Spending Account Subject to the special Health FSA limitation discussed later Dependent Care Account Deposits to a Health Savings Account (if otherwise eligible)

18. Opt Out Plan Income Tax- The $150 is NOT subject to Federal or State income tax withholding, FICA or Medicare or FUTA tax ACA Affordability- $150 is added to Ted’s cost of coverage Ted’s contribution for coverage:$175/month Amounts Ted received or could have received:$150/month Cost of Ted’s Coverage:$325/month $325 ÷ $2,000 = 16.25% NOT AFFORDABLE IPERS- The $150 is NOT IPERS covered wages (because Ted can not elect to receive cash)

19. Opt Out Plan EXAMPLE 7: Limited “Medical Only” Benefits – No Cash Ted can ONLY use the $150 Opt Out amount for one or more of the following “medical only” benefits (no cash out option): Dental or Vision Insurance Health Flexible Spending Account Subject to the special Health FSA limitation discussed later It CANNOT be used for: Cash out Dependent Care Group Term Life Insurance Deposits to a Health Savings Account

20. Opt Out Plan Income Tax- The $150 is NOT subject to Federal or State income tax withholding, FICA or Medicare or FUTA tax ACA Affordability- The $150 reduces Ted’s cost of coverage Ted’s contribution for coverage:$175/month Amounts Ted received or could have received: $0/month Cost of Ted’s Coverage:$175/month $175 ÷ $2,000 = 8.75% AFFORDABLE IPERS- The $150 is NOT IPERS covered wages (because Ted could not elect a cash benefit) This may seem like a good strategy, however:

21. Special Rule for Health FSAs If Ted does NOT have a cash out option, Ted’s annual Health FSA contribution is limited to: The greater of: $500, or 100% of Ted’s salary deferral for Health FSA benefits Example A:Ted elects not to purchase Health FSA benefits from his compensation. Ted’s maximum Health FSA election for the year is $500. Unless he purchases vision or dental insurance, he will forfeit $1,300.00 in benefit dollars. Example B: Ted elects to purchase at least $1,800 of Health FSA benefits from his compensation (up to $2,550 for 2016). Ted’s can use the entire $1,800 as a Health FSA election. Additional Caution: A maximum of $500 of unused benefits can be carried over.

22. Rewards/Flex Credit Plan

23. A “rewards” plan and a “Flex Credit” plan are two sides of the same coin. Rewards plan example: If Ted chooses Benefit Package A, Ted gets no reward. If Ted chooses Benefit Package B, Ted gets a $150 reward Flex Credit plan example: Ted gets $150 of flex credits Benefit Package A costs $150 flex credits Benefit Package B costs $0 flex credits. Ted can use his remaining $150 flex credits as a reward.

24. Rewards/Flex Credit Plan EXAMPLE 8: Cash Only For the following examples, assume that Ted’s contribution to the cost of SO/MV coverage is $250 (rather than $175 as in the previous examples) Ted can elect Benefit Package A or Benefit Package B. If Ted elects Benefit Package B, Ted receives $150/month additional cash compensation. (NOTE: If Ted receives something for waiving all insurance coverage, then this is an Opt Out plan.)

25. Rewards/Flex Credit Plan Income Tax- If Ted receives cash, $150 is subject to Federal & State income tax withholding and FICA, Medicare and FUTA tax ACA Affordability- Because Ted can receive cash, none of the $150 reduces Ted’s cost of coverage. Ted’s contribution for coverage:$250/month Amount of ER contribution taken into account $0/month Cost of Ted’s Coverage:$250/month $250 ÷ $2,000 = 12.5% NOT AFFORDABLE IPERS- $150 is IPERS covered wages even if Ted does not take the cash

26. Rewards/Flex Credit Plan EXAMPLE 9: Cash and/or Pre-tax Benefits Ted can elect Benefit Package A or Benefit Package B. If Ted elects Benefit Package B, Ted receives $150/month in additional cash compensation or he may elect one of the following: Dental, Vision or Group Term Life Insurance Health Flexible Spending Account All amounts are considered “employee” contributions toward the annual $2,550 contribution limit Dependent Care Account Deposit to a Health Savings Account (if otherwise eligible) If Ted waives coverage, Ted receives nothing.

27. Rewards/Flex Credit Plan Income Tax- Any amount taken in cash is subject to Federal & State income tax withholding and FICA, Medicare and FUTA tax Any amount used to pay for any of the other benefits, it is NOT subject to any of the above taxes ACA Affordability- Because Ted can receive cash and “non-medical” benefits, none of the $150 reduces Ted’s cost of coverage Ted’s contribution for coverage:$250/month Amount of ER contribution taken into account: $0/month Cost of Ted’s Coverage:$250/month $250 ÷ $2,000 = 12.5% NOT AFFORDABLE IPERS- $150 is IPERS covered wages even if Ted does not take the cash

28. Rewards/Flex Credit Plan EXAMPLE 10: Pre-Tax Benefits Only Ted can elect Benefit Package A or Benefit Package B. If Ted elects Benefit Package B, Ted receives $150/month which Ted can ONLY use for the following: Dental, Vision or Group Term Life Insurance Health Flexible Spending Account Subject to the special $500/100% matching limitation Dependent Care Account Deposit to a Health Savings Account (if otherwise eligible) If Ted waives coverage, Ted receives nothing

29. Rewards/Flex Credit Plan Income Tax- No amounts are subject to tax. ACA Affordability- Because Ted can receive “non-medical” benefits, none of the $150 reduces Ted’s cost of coverage Ted’s contribution for coverage:$250/month Amount of ER contribution taken into account: $0/month Cost of Ted’s Coverage:$250/month $250 ÷ $2,000 = 12.5% NOT AFFORDABLE IPERS- None of the $150 is IPERS covered wages

30. Rewards/Flex Credit Plan EXAMPLE 11: Limited “Medical Only” Benefits – No Cash Ted can elect Benefit Package A or Benefit Package B. If Ted elects Benefit Package B, Ted receives $150/month which Ted can ONLY use for the following: Dental or Vision Insurance Health Flexible Spending Account Subject to the special $500/100% matching limitation Ted cannot use any part of the $150/month for: Group Term Life Insurance Dependent Care Account Deposit to a Health Savings Account If Ted waives coverage, Ted receives nothing

31. Rewards/Flex Credit Plan Income Tax- No amounts to tax. ACA Affordability- Because Ted can receive only “non-medical” benefits, the $150 reduces Ted’s cost of coverage Ted’s contribution for coverage:$250/month Amount of ER contribution taken into account:$150/month Cost of Ted’s Coverage:$100/month $100 ÷ $2,000 = 5% AFFORDABLE IPERS- None of the $150 is IPERS covered wages

32. Compliance Issues

33. Different groups of employees can receive different benefit amounts. Employees covered under a collective bargaining agreement may be considered separately. Example: Administrative Staff receive $500 Opt Out Non-administrative staff receive $350 Opt Out Bargaining Unit employees (teachers) are not included in this test

34. Compliance Issues As long as: No Highly Compensated Employee receives “Opt Out” amounts or “Rewards/Flex Credits” greater than those available to a non- discriminatory group of employees (50% will always pass). IPERS has a 25% test that may limit the amount of employer contributions made for Highly Compensated Employees that may be considered covered wages Highly Compensated means any of the following: Compensation higher than $120,000/year An officer A more than 5% owner A spouse or dependent of any of the above For many school districts, only the Superintendent will be an “officer” or will have more than $120,000 in compensation.

35. Compliance Issues As an ERISA plan, the language in your plan document and Summary Plan Description must always authorize and reflect what you are doing in practice.

36. Effective Dates The rules for Opt Out plans that were “in place” on December 16, 2015 are effective after final regulations are issued. It is possible that a distinction may be drawn between “unconditional” plans and plans that condition opt out payments on proof of other coverage. It is anticipated that final regulations will be issued soon (within a few months). The rules for Rewards/Flex Credit plans are effective for plan years beginning on or after January 1, 2017 if the plan had been “in place” on December 16, 2015. Special IRS guidance on what it means to be “in place” on December 16, 2015 The rules are effective immediately for new plans.

37. Effective Dates Effective January 1, 2017, employers must annually certify to IPERS, on a form approved by IPERS, that their Section 125 plans meet all IRC requirements.

38. Planning Options

39. Problem: To preserve affordability, the ability to elect cash or other benefits must be limited. Affect: Because of these restrictions, some employees may forfeit benefit dollars they cannot use. Solution: Use part of the Reward to satisfy affordability but restricting its use to “medical only” benefits. The remainder of the Reward can be used for cash or other benefits.

40. Planning Options Opt Out Example: Ted is required to contribute $100/month to the cost of SO/MV coverage. If Ted Opts Out of coverage, he gets $150/month cash ACA Affordability Analysis- Ted’s contribution for coverage: $100/month Cash Ted received or could have received: $150/month Cost of Ted’s Coverage:$250/month $250 ÷ $2,000 = 12.5% NOT AFFORDABLE New Plan Design – If Ted Opts Out of coverage he gets $75/month in cash and a “medical only” benefit amount of $75/month ACA Affordability Analysis- Ted’s contribution for coverage: $100/month Cash Ted received or could have received: $75/month Cost of Ted’s Coverage: $175/month $175 ÷ $2,000 = 8.75% AFFORDABLE

41. Planning Options Reward/Flex Credit Example: Ted is required to contribute $250 of the cost of SO/MV coverage. Ted can election Benefit Package A or Benefit Package B. If Ted elects Benefit Package B he gets a reward/flex credit amount of $150 that he can take in cash or any pre-tax benefit. ACA Affordability Analysis- Ted’s contribution for coverage:$250/month Contribution received for Ted: $0/month Cost of Ted’s Coverage:$250/month $250 ÷ $2,000 = 12.5% NOT AFFORDABLE New Plan Design – If Ted elects Benefit Package B, he gets $75/month in cash (or other benefits) and $75/month limited to “medical only” benefits ACA Affordability Analysis- Ted’s contribution for coverage:$250/month Contribution received for Ted: $75/month Cost of Ted’s Coverage:$175/month $175 ÷ $2,000 = 8.75% AFFORDABLE

42. Questions REMINDER: We will be at booth #73 at the IASBO Conference in Ames on March 30 th if you have questions or would like to discuss any unique circumstances. Or you can call Fawn at 1-800-383-1623 if you have any immediate questions.