HEART Act's Impact on Employee Benefits

The Heroes Earnings Assistance and Relief Tax (HEART) Act, enacted this summer, contains some easily-overlooked provisions that may have significant impact on your company's employee benefit programs. In general, these provisions are voluntary and only apply if you have employees who have been called to active military duty. However, a few provisions are mandatory.

Death of an employee while on active military duty: This new requirement affects all retirement plans, including 401(k) plans, and provides that participants who die while on active military duty must be considered employed on the date of their death under terms of the plan. As a result, if a plan fully vests an employee upon death, then the retirement benefit is fully vested for the deceased veteran. This rule can have a more complex impact on Defined Benefit plans that often have additional benefit accrual or pre-retirement survivorship benefits that are applicable upon an employee's death. Since this provision is retroactive to January 1, 2007, an employer may need to adjust the benefit paid to the survivors of a veteran who died in 2007 or 2008, depending upon the actual terms of the plan.

Retirement Plan service credit: Currently, retirement plans are required to give service credit to a returning employee for the period of the employee's military service, provided the return to work is timely. Thus, if an employee is on active duty for a year, the retirement plan must include that year as a year of service, as long as the employee has returned to work shortly after returning from active duty. The HEART Act has created an option for plans to give this benefit accrual credit to those employees who cannot return to employment due to death or disability that occurred while on active military duty. This credit can be retroactive to January 1, 2007 and applied to the employee's account as if the employee had returned to work the day before death or disability. By electing to provide this credit, the plan would allocate any matching contributions to the veteran's 401(k) account based on the 12-month average contribution made by this veteran prior to going on active duty.

Differential Pay: The Act ends the confusion over the proper treatment of "differential pay" provided by the employer to make up the difference between normal pay and active duty military pay as to whether it is a benefit or compensation. Differential pay is defined now as compensation and thus the individual on military leave can make salary deferral contributions from that pay. In addition, the employer is required to withhold federal income tax payments on this pay. This "compensation" does not change the ability of the employee on active duty to receive a distribution of elective deferrals as if separated from service. This change is for all differential pay paid after 2008.

Distribution from Cafeteria Plans: A Flexible Health Spending Account plan may permit a "qualified reservist distribution" (QRD). This provision would allow an employee who deferred funds into an FSA to receive a distribution of these funds without having incurred a medical expense. (The Act does not provide for a similar distribution from a Dependent Care FSA.) To be eligible for a QRD, the employee must have been called up for active duty for a period of at least 179 days or an indefinite period. This distribution would be included in the taxable income of the employee in the year distributed. A QRD can be anytime after June 18, 2008 provided the plan has been amended by December 31, 2008 to permit this distribution.

Timing: Most retirement plans are required to amend the plan by Dec. 31, 2010 for the HEART Act changes, although plans may be administered under these terms now. Plan administrators who elect to add any of these features should be careful to apply them consistently and in a non-discriminatory manner to all employees. Contact our ERISA benefits attorneys if you have questions regarding the HEART Act or need assistance in updating your company's benefits plans to comply with the HEART Act.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.