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July 07, 1997 01:00 AM

BUDGET BILL HITS EMPLOYERS: MEDICAL COSTS COULD SKYROCKET

Vineeta Anand
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    WASHINGTON - Large corporations paying their retired workers' medical bills could see their financial liabilities jump and their reported profits drop if Medicare's eligibility age rises.

    A provision hiking the eligibility age to 67 from 65 is contained in the budget package that passed the Senate late last month. It is not part of the House version, so its fate rests with a joint conference committee.

    Companies' reported liabilities could increase 5% to 25%, according to Julie Cantor-Weinberg, associate director of employee benefits at the National Association of Manufacturers, Washington.

    Accounting rules require companies to disclose in their financial statements the present value of their anticipated future expenses for retiree health care plans. Under Financial Accounting Standard 106, companies would have to start reporting this increased liability next year, if the budget provision is approved.

    "We have heard of situations where companies have estimated their increased liability at $80 million in one year when the provision is fully phased in," said Frank McArdle, manager of the Washington office of Hewitt Associates. Companies with a young work force might see the present value of their liabilities rise 16%, while manufacturing companies with a graying work force might see an 18% increase when the provision is fully phased in, he said.

    As many as 79% of 1,050 large corporations offered some type of retiree health care coverage in 1996, according Hewitt data.

    If Medicare's eligibility age jumps, companies that have promised to pay for medical expenses of thousands of workers who accepted early retirement as part of a downsizing probably will be hardest hit. Especially at risk are companies whose plans offer coverage until "Medicare eligibility age," rather than stipulating age 65.

    Many companies could be tempted to drop their plans, or to scale back other employee benefits if they pick up two more years of retiree medical, benefits consultants and lobbyists say.

    Under the Senate version, the hike in the eligibility age would be phased in over a 23-year period starting in 2003.

    Still, because such benefits, unlike pensions, are not vested, and companies already have scaled back their plans dramatically since FAS 106 became effective in 1993, "most employers have been very judicious about not creating any promise or contract for retiree medical benefits," noted Martha Priddy Patterson, director of employee benefits policy and analysis in the Washington office of KPMG Peat Marwick.

    Employer stock limits

    Another zinger in the Senate's version aims to prevent companies from forcing employees to invest more than 10% of their contributions in company stock, although employees may still invest all of their money in company stock if given other choices.

    "Companies could require that all of the employee contributions go into a balanced fund, or a bond fund, or a stock fund, but they can't require the contributions all go into company stock," Mr. McArdle explained.

    The amendment, offered by Senate Finance Committee Chairman William V. Roth Jr., R-Del., is a watered-down version of one originally introduced by California Democrat Sen. Barbara Boxer. Although it would affect "a relatively small universe" of retirement plans, employers still worry "it would be strengthened in the future,"said Ann L. Combs, principal in the Washington office of William M. Mercer.

    In its current form, the provision would only affect plans where employers do not give workers a choice in investing their retirement dollars: Companies still will be free to direct their matching contributions to company stock, or to encourage employees to invest in company stock through higher matching contributions.

    Companies also may still require employees to invest 1% of pay in company stock, while giving them choices on investing the remainder in other investments.

    The provision would not affect employee stock ownership plans. In fact, because the provision treats employees' elective deferrals as a separate plan, Ms. Combs suggests companies wanting to funnel employees' retirement dollars into company stock need simply convert that piece into an ESOP to circumvent the provision.

    Capital gains conundrum

    Also potentially worrisome to employers is the proposed cut in the capital gains tax.

    The Republican proposal would exclude the first half of gains from any taxes, and subject the remaining half to a 20% rate, down from the current 28%. President Clinton has offered an alternative that would exclude 30% of gains from tax.

    Either way, some participants might find it more advantageous to tuck away money in taxable mutual funds than in tax-sheltered employer-sponsored retirement plans because distributions from 401(k) retirement plans (and tax-deductible individual retirement accounts) are taxed as ordinary income, which can top 40%.

    What's more, workers who have built up retirement nest eggs in the hundreds of thousands of dollars also risk paying a 15% excise tax on retirement plan distributions in excess of $150,000. As a result, some workers - especially those that have a "buy and hold" investment strategy, and invest in fast-growing stocks that pay little or no dividends, or in mutual funds that have a low portfolio turnover - might find it preferable to keep their money in taxable investments, suggests Robert B. Coplan, national director of Ernst & Young's center for family wealth planning in Washington.

    But, with the budget bill also proposing to remove the 15% excise tax on large distributions, and employer money added to retirement plan contributions, most workers still will want to keep their money in employer-sponsored plans, he explained. "In most cases, tax-free investing will still be preferable," he said.

    Non-discrimination hurdle

    Meanwhile, because the budget package might make IRAs more attractive than employer-sponsored retirement plans to lower-paid workers, some companies might flunk non-discrimination tests proving they don't offer richer benefits to top executives, according to William L. Sollee Jr., principal consultant in the Washington office of Price Waterhouse L.L.P.

    In order to pass these tests, companies must ensure higher-paid executives do not contribute disproportionately more than lower-paid workers.

    Lower-paid employees of companies that don't match 410(k) contributions might prefer to sock away $2,000 a year in an IRA, Mr. Sollee explained.

    Such workers often find it hard to save for their retirement and often need easy access to their savings.

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