Getting rising health and dental benefit costs off the books
Similar to defined benefit pension plans, traditional health and dental benefit plans are like an open-ended liability for employers. Providing health and dental benefits to employees has always been costly and it isn’t getting any cheaper – health care costs have doubled over the past decade.
In the 1980s and 1990s when pension surpluses were prevalent, it was a lot more common for companies to offer retirees group health and dental benefits. With baby boomers retiring en masse and health care costs expected to keep rising, it may be worth considering a voluntary buyout program.
What is a voluntary buyout program?
A voluntary buyout program is a way to get retiree health and dental benefits off the books. Although minor changes can be made to retiree benefits, employers aren’t generally permitted to go back and retroactively change or eliminate retiree health and dental benefits. This leaves employers at the mercy of skyrocketing health costs.
Employers used to offer retiree benefits as an employee retention strategy; although benefits in retirement are still common in the public sector, most private sector companies have stopped offering them to existing workers. Buyouts aren’t exclusive to health and dental benefits – more and more employers are de-risking in other areas, including pensions and life insurance.
Who is eligible?
Current retirees, surviving spouses, and active employees who have been promised benefits in retirement are eligible to receive a buyout. Here’s how a buyout program works: retirees are offered a limited-time chance to receive a lump-sum cash payment in exchange for permanently opting out of health and dental benefits. Retirees that don’t respond to the offer by the deadline or do not wish to participate will remain covered under health and dental benefits.
How costly is a buyout?
Calculating the cash settlement amount for retirees can be complicated, so it’s probably best to let your health benefits administrator handle it. The lump-sum payment received by each retiree is based on several factors, including existing coverage under the plan, mortality rates, and whether or not the employee has dependents covered under the plan. You’ll also have to pay your benefits administrator fees to assist you with the buyout. The savings you’ll attain (which are unknown) have to be less than the costs associated with the buyout for it to be worth it.
The downside to buyout programs
As the name alludes to, the program is voluntary. An employer cannot force retirees to accept a buyout. There are no guarantee retirees will accept the buyout offer in great numbers. In fact, the take-up rate for voluntary buyout programs hasn’t been spectacular.
A voluntary buyout program can be attractive for healthy retirees without a family history of the disease, but for those in poor medical health, it may not be the best choice. It may be very costly for retirees to obtain individual health and dental insurance. Although provinces offer medical benefits, the amount of coverage depends on where employees reside and there’s no guarantee it will be there when they need it.
Prior to 2012, the buyout program was a lot more attractive for retirees. An employer could pay out lump sums without withholding tax. However, starting in 2012, voluntary lump-sum payments are to be reported on T4A slips and included as taxable income for retirees. Depending on the size of the lump sum payment, it may push retirees into a higher marginal tax bracket and lead to a claw-back in means-tested benefits like Old Age Security and Guaranteed Income Supplement.
If you’re currently outsourcing your health benefits administration to a third-party provider like Sun Life or Great-West Life, it makes the most sense to initiate a discussion. Your administrator can help break down the costs to see if it makes the most sense for your company’s balance sheet.