Payroll Brass Tax: SUB Plans—A Cost-Effective Alternative to Traditional Severance

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Mike Mahoney: Welcome to this month’s installment of Payroll Brass Tax, the podcast where we discuss hot topics in employment taxes. I’m your host, Mike Mahoney, a shareholder in Ogletree’s Morristown, New Jersey office, and the Chair of the Employment Tax Group. Today, we’re diving into the world of supplemental unemployment benefits, or SUB Plans. Joining me is Elizabeth Lutes, Executive Vice President of Transition Services, Inc., and Administrator of SUB Plans. Welcome, Elizabeth, and thank you.

Elizabeth Lutes: Thank you so much for having me. I’m excited to be on this with you.

Mike Mahoney: Let’s start with some of the basics. What exactly is a Supplemental Unemployment Benefit Plan, or SUB Plan?

Elizabeth Lutes: Great question. It’s amazing how many people don’t know about this, despite the fact that this structure has been around for well over 60 years. It is an alternative structure for paying severance, or separation benefits, to employees who are involuntarily terminated. So due to a reduction in force. Might be temporary, might be permanent, but it is a reduction in force.
So, a SUB Plan, unlike traditional severance, which is typically paid as a lump sum, SUB Plans integrate with State Unemployment Compensation to provide ongoing financial support to displaced employees. Traditional severance is usually a fixed benefit. It’s a formula. It’s based on level and tenure with the organization. And most companies pay severance as a lump sum, which is like a taxable. SUB Plans, on the other hand, are intended to serve as a bridge to the next employment opportunity, and they are integrated with State Unemployment Benefits.
When a SUB Plan is in place, the benefits that the employer pays are paid as benefits, not wages, and therefore are non-taxable. So, two components of a SUB Plan are: one, the integration with state unemployment, and two, the non-employment taxable status.

Mike Mahoney: Well, on this podcast, we always love to talk about tax savings. Can you go into a little more detail on how SUB Plans result in employment tax savings?

Elizabeth Lutes: Sure. As you know, our wages are subject to payroll taxes, like FICA, FUTA, SUTA, and that results in a combined 15.3% tax on the wages for both the employer and the employee. When a SUB Plan is in place, and these employer payments are classed as benefits, then there are no employment taxes. And therefore, there are savings both for the employer and for the employee.

Mike Mahoney: That’s a substantial amount of savings. What are some of the key reasons an employer might choose to implement a SUB Plan?

Elizabeth Lutes: Well, there are several key reasons. First, SUB Plans are cost-efficient. Promotes fiscal responsibility by reducing the overall cost. SUB Plans also ensure benefit equity across all states, as the structure is consistent regardless of the local unemployment laws.
So right now, for a multi-state employer, if they have employees in Illinois, for example, that employee can receive severance and state unemployment at the same time. However, in the state of Georgia, an employee for that same company could not receive state unemployment until the severance payment, the period that it’s intended to cover, has expired. So, for a multi-state employer, SUB Plans actually ensure benefit equity across all states. And the last thing is that SUB Plans are consistent with the original intent of severance. The original intent was to provide a bridge to the next employment opportunity.

Mike Mahoney: It sounds like there are many advantages. One of the things in the employment tax space that we’re always concerned about, and I imagine finance leaders may also be concerned about, would be the use of the SUB Plan, and whether that simply shifts the costs from the payroll taxes to a higher state unemployment insurance tax rate. What have you seen in the data once the plan is up and running? Does that actually occur?

Elizabeth Lutes: That has never occurred. It’s a great question because it is a common concern. But first of all, SUTA taxes tend to be quite low. The actual dollar amount is not very much. Second, the tiers of the SUTA tax rate are not very precise. So, many employers are already at the highest SUTA tax rate, so there’s no impact by implementing a SUB Plan. Third, for those companies who are not already at the highest SUTA rate, even if they bump up to the next rate or the highest rate, that dollar increase in the tax is so much smaller. It is a fraction of the amount of the savings that occurs through a SUB Plan, primarily through the UI offset and the elimination of payroll taxes.

Mike Mahoney: When we’re thinking about SUB Plans, are there any specific design alternatives that employers can consider within the SUB Plan context?

Elizabeth Lutes: Absolutely. There’s a lot of design flexibility. In the most basic version of a SUB Plan, there are three components of savings. The first is the elimination of the payroll taxes. That’s actually the smallest component of the savings. The second component of the savings is the integration with state unemployment. As you probably know, state unemployment income can vary from maybe $200 a week to up as high as seven, $800 a week. So, that amount is deducted from the employer payments, and that’s a significant area of savings for SUB Plans.
The third area of savings for SUB Plans is with the duration management. So, if somebody is entitled to 12 weeks of benefits, they get a job after four weeks. Then, in the most cost-efficient version of the plan, there’s eight weeks of salary that the company has saved. They’re no longer paying. Yet, the former employee has actually been bridged to their next employment opportunity. So, one of the key design features of a SUB Plan is that an employer can offer what we call a re-employment bonus. So, in that same example where somebody found a job at four weeks, yet they were entitled to 12 weeks of benefit, the company can choose to pay half of that remaining amount as a re-employment bonus. This would be a taxable payment, so it is FICA taxable. However, that incents the employee to return to work early, which is a great thing, and it still allows the employer to save significant funds. So, that is one of the key design options. There are others, such as extending the benefit period if people have a hard time finding work, or paying a flat amount on top of the state UI, as opposed to correlating it to the pre-termination salary.

Mike Mahoney: That’s quite a bit of flexibility. Anytime I think of flexible plans that result in savings, I think about the hurdles that an employer may have to surmount in order to operate it. What about the legal and administrative aspects of a SUB Plan? Are there any specific requirements or considerations for implementing one of these plans?

Elizabeth Lutes: For sure. There are. And it can seem complex. That really is one of the values of having some external expertise: a third-party administrator. There are the original IRS guidelines for a SUB Plan. It is an ERISA plan, so it must comply with the ERISA requirements, which means that there needs to be a plan, a summary plan description, a claims procedure, and a plan administrator. There are still some states that require prior approval or registration of a SUB Plan. For most of those states, it’s a very straightforward process. So, while saying that may sound like it’s a lot of work, really, it is very easily managed. And then, one of the legacy…or one of the original requirements of the IRS was that SUB Plans be paid through a trust. However, there are only a few states that still require that, and it does not have to be a complicated funded trust. It can be a very simple administrative step. So, the key is to have a third-party administrator, which really understands what it takes to have a SUB Plan work effectively and legally in all 50 states.

Mike Mahoney: For employers used to lump-sum severance payments, what are the three biggest process changes they’ll feel on day one of switching to a SUB Plan, and how have your clients managed that change management curve?

Elizabeth Lutes: First, let me talk about what doesn’t change. The HR representative still holds the termination discussion with the employee. They still issue the release and waiver, which makes the separated employee eligible for their benefit. And once the individual has returned the sign release, HR makes them eligible to receive the benefit. So those steps don’t change. What does change is that the third-party administrator will manage all of the communication with the separated employees from that point forward, will determine how much of a payment they are eligible for and when, and make sure that the payroll team has that information when they need it to upload into payroll. So, what is different is that there’s a data exchange process, like I just referred to, that’s established between the administrator and the employer, and using a secure file transfer protocol, HR will upload one file with all the HR data, and a second file with payment eligibility. This can be an automated process. And then the administrator has that information in its secure system and can manage all the payments from that point forward. So, the data exchange is secure. It’s highly automated. It’s designed to integrate smoothly with whatever the employer’s existing system is. The last thing I would say about this change management is that rarely is HR viewed as having a focus on cost savings. And we know that the cost of benefits mostly goes up. When HR takes on a SUB Plan and generates substantial savings, they get to be the hero. We have one CHRO who saved her company over 4 million in the first year of SUB Plan operations, which is a tremendous result. So, often, when we think about change management, we think about it as a negative, and yet that’s a change that’s a real boon for the company. So, the way to have this change be successful is by making sure all the right people are included right from the beginning. This is typically a C-suite decision to implement a SUB Plan, and then you need representatives from payroll, from legal, from finance involved right in the beginning, so that everybody understands what’s happening and what it’s going to take to have it work. Once that initial 60, 90-day period has been navigated successfully, then the plan’s up and running and is there to be used when needed.

Mike Mahoney: It seems like having a cross-functional team is exceptionally important to have all the key stakeholders involved from the outset. What about the impact SUB Plans have on the employees who are being either furloughed or laid off?

Elizabeth Lutes: Many people…you could say most people…don’t really like change. So, there is a change to be managed with the employees as well. However, I have yet to meet an employee who took a job because of their severance policy. Mostly, people don’t even think about that. So what matters is the communication to the employees about what their benefit is and how they can take advantage of it. And also true, that employees understand the logic of, “Oh, my income is going to be maintained while I’m unemployed.” So, there is a logic to a SUB Plan that is very easy to grasp. So, generally, employees adapt really quickly to SUB Plans. As long as employers are straightforward about what the new benefit is, what the logic for it is, what they’re actually going to receive, then it’s a very smooth transition.

Mike Mahoney: So, it sounds like communication is key. SUB Plans hinge on weekly benefit-contingent payments of state unemployment insurance. How do employers keep ex-employees engaged with filing requirements, and still protect themselves from overpayment or fraud?

Elizabeth Lutes: That’s a great question. It’s really important to have a clear process, clear system, for employees to communicate their unemployment status. So, for TSI, employees…or former employees are required to validate weekly that they are still unemployed and they’re still looking for work. It’s a very short process. They can do it online, they can do it through an automated phone system, or they can call into our call center and talk to somebody if they like. And there are just a couple of questions to answer: Did you file for state UI? Are you still unemployed? And if they answer yes to both, then they are eligible to receive their next payment.
What we found is that, because SUB is tied to state UI, people are reluctant to lie about it. So, if they’re receiving their state UI, they let us know that they’re still unemployed, we have a very low level of fraud. And of course, filing a false claim with the state can jeopardize their UI eligibility. So, in our experience, people are generally honest about this. The other thing is, people have to attest to us, they have to validate that they’re unemployed in order to receive their payment, but we also received their determination of benefits notice from the state. So, we have proof that they actually are receiving their benefits. And we have found that employees think the system is very simple, and that it minimizes fraud.

Mike Mahoney: Could you walk us through a real-world case, maybe giving us some details on company size, number of affected employees, and the duration of the program where a SUB Plan saved 30 to 50%, versus a traditional severance program? What were the hidden return on investment drivers in those instances?

Elizabeth Lutes: Sure. We have one client, a multi-state employer…manufacturing company…whose business model was…they had frequent merger activity. And they used a SUB Plan over a seven-year period to manage all of those restructuring events. So this employer, if they had paid these 1,451 employees traditional severance, it would’ve cost them $11 million. Under a SUB Plan, it costs 6.5 million. So, that’s savings of 4.5 million, or 41%. Huge, right? That is really significant savings to the bottom line. So, the key drivers to that savings of 4.5 million were, one, the payments stopped when people returned to work. So, people had a bridge to their next employment opportunity, and then their benefits stopped.
The payments were issued as benefits opposed to wages, so there were no payroll taxes. The TSI handled all the eligibility, the compliance, the support to the participants, so that the actual workload on HR was minimal. We have worked with organizations ranging from a thousand employees to well over a hundred thousand employees. So, important to register that it’s the percent of savings that is consistent, right? That 30 to 50% is what’s consistent. The dollar amount has everything to do with the company size and the level of activity, but 30 to 50% savings is regularly achieved through the implementation of a SUB Plan.

Mike Mahoney: Thanks, Elizabeth. Before we wrap up, can you share any final thoughts or tips for employers considering a SUB Plan?

Elizabeth Lutes: Of course. First, I would say, do consider it. At any period of time, but especially these days, there’s so much uncertainty. Uncertainty in the market, uncertainty in the economy. And in my experience, most people are working really hard to be prepared. And having a SUB Plan in place is one way to be well-prepared for whatever may come down the pike. Because once you have a SUB Plan in place, it’s there to be used. When you have activity, you can use it. When you don’t, it’s just there waiting. So, considering…regardless of the current situation of your business or your company, actually, evaluating a SUB Plan makes a lot of sense.
So, the first step is to perform that evaluation and that analysis, and that’s something that TSI facilitates. There’s no cost to it. We just take a look at severance data and compare it to…if a SUB Plan had been in place. And that way, the very tailored results of what a SUB Plan would be for a particular employee are obvious and can be considered. As I said a little bit earlier, also really important to have a cross-functional team in place. So that you’ve got legal involved, you’ve got payroll involved, you’ve got HR involved, you’ve got HRIT involved, so that you can make sure that the plan is designed in a way that best works for the employer, and that everybody gets to weigh in and own it. A typical implementation process for a company that’s not in a hurry is 60 to 90 days, and that just allows to methodically go through the various pathways that are required to have a SUB Plan in place. We have had highly motivated employees implement a SUB Plan in a much shorter period of time: two to four weeks. So, we’re happy to work with employers who have a short timeline. But, typically, it’s really nice to have 60 to 90 days.
One of the things we also do is we train HR. How do you talk about a SUB Plan? How do you talk about the change? Making sure that employees are really well-prepared for obtaining their benefits. So, a SUB Plan is a little-known structure that is a great solution for an employer because of its cost efficiencies, and a great solution for employees who are being let go through no fault of their own, because it provides a stable income while they’re unemployed.

Mike Mahoney: That’s great advice, Elizabeth. Thank you so much for joining us today and sharing your insights on SUB Plans. Really appreciate it.

Elizabeth Lutes: Truly my pleasure. Thank you for having me. I’ve really enjoyed it.

Mike Mahoney: And thank you to our listeners for tuning into this month’s installment of Payroll Brass Tax. We hope you found this episode informative. If you have any questions or topics you’d like us to cover in future episodes, please reach out. Until next time, take care.

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