Life Insurance in Split-Funded Defined Benefit Plans

1
Life Insurance in Split-FundedDefined Benefit
Plans

• Bill Schatz, Regional Marketing Director

2

• This material was not intended or written to be
  used, and cannot be used, to avoid penalties
  imposed under the Internal Revenue Code. This
  material was written to support the promotion or
  marketing of the products, services, and/or
  concepts addressed in this material. Anyone to
  whom this material is promoted, marketed, or
  recommended should be urged to consult with and
  rely solely on their own independent advisors
  regarding their particular situation and the
  concepts presented here.

3
What Is a Qualified Retirement Plan?

• Provides retirement benefits
• Must meet specific IRC requirements
• Qualifies for tax-favored treatment
• Deductible contributions
• Tax-deferred growth
• Plan cannot discriminate

4
Qualified Plan Comparison
Defined Benefit Defined Contribution
Retirement benefit defined in advance Retirement benefit based on contributions and performance of plan investments
Employer bears investment risk Participant bears investment risk
Life insurance as a plan asset mayincrease contributions Life insurance as a plan asset does not increase contributions
5
Why Are Defined Benefit Plans Popular Again?

• Favorable pension reform EGTRRA 2001
• Compensation/contribution limit increases
• No family aggregation
• Pension Protection Act of 2006
• Deductibility limits for contributions to both
  defined contribution and defined benefit plans
  (covered by the PBGC) sponsored by the same
  employer repealed effective 1/1/2008
• Transitional relief provided

6
EGTRRA Increases Compensation and Benefit
Limitations Defined Benefit Plan
2005 2006 2007 2008 2009/2010
IRC Section 401(a)(17) Compensation 210,000 220,000 225,000 230,000 245,000
IRC Section 415 Annual Benefit 100 of pay not to exceed 170,000. Reduced if benefit starts before age 62. 100 of pay not to exceed 175,000. Reduced if benefit starts before age 62. 100 of pay not to exceed 180,000. Reduced if benefit starts before age 62. 100 of pay not to exceed 185,000. Reduced if benefit starts before age 62. 100 of pay not to exceed 195,000. Reduced if benefit starts before age 62.
7
Traditional Defined Benefit Plans vs. 412(e)(3)
Plans

• Both are defined benefit plans
• Similar client profiles
• Large tax-deductible contributions
• Differences
• Investment flexibility vs. product guarantees
• Minimum funding standard

• Actuarial Certification

8
What is a "Split-Funded" Defined Benefit Plan?

• A traditional defined benefit plan that includes
  both
• Investments
• Life insurance

9
What About the Plan Benefit Options?

• Taken as retirement distributions
• IRA rollover
• Rollover to another qualified plan

10
Types of Investments

• Stocks
• Bonds
• Mutual funds
• Annuities (fixed or variable)

11
Types of Life Insurance Used

• Whole life
• Term
• Universal life
• Variable universal life
• No definite ruling on VUL use in DB plan

12
How Much Life Insurance Can Be Used?

• Incidental benefit limitations
• 100 times test
• 50 of annual contribution for whole life
• 25 of annual contribution for universal life or
  term
• Defined contribution plans
• Seasoned money
• Potentially, all employer funds that have been in
  the plan over two years can be used to purchase
  life insurance

13
Why Buy Life Insurance Inside Qualified Plan?

• Self-completion
• Pre-tax dollars
• Portability

14
What if Life InsuranceIs Still Needed at
Retirement?

• Receive policy as plan distribution
• Purchase policy from the plan
• Roll policy to profit sharing plan
• New plan must allow for the purchase of life
  insurance

15
Tax Implications

• Employer contribution is tax-deductible
• Death benefit in excess of cash value is
  received federal income taxfree
• Participant recognizes economic benefit
• Generally, policy proceeds are includable in the
  gross estate

16
Valuing the Life Insurance Policy

• Rev. Proc. 2005-25
• Guidance on fair market value
• Two safe harbor formulas

17
Who Might Benefit from a Split-funded Defined
Benefit Plan?

• Ideal candidates include
• Highly paid business owners
• Companies with few or no employees
• Companies with many employees and multiple
  owners/partners
• Companies with existing 401(k)/profit sharing
  plans

18
Role of the Third-Party Administrator

• Develops suitable defined benefit plan proposal
• Assists in preparation of plan documents
• Performs annual administration
• Calculates plan contributions (including
  Actuarial Certification)
• Prepares required reports
• Handles distributions
• Performs incidental benefits testing

19
Hypothetical Example 1 Surgical Practice

• Doctor 700k salary
• Wife 100k salary
• 10 employees 627k total salary
• Existing Profit Sharing Plan
• Doctor 45k contribution
• Wife 25k contribution
• 10 Employees 151k contribution
• PROBLEM The employee cost is twice that of the
  owner

20
Example 1 (continued)

• Solution
• Layer split-funded defined benefit plan on top
  of profit sharing plan
• New contributions
• Doctor 256k
• Wife 92k
• 10 Employees 151k NO CHANGE
• 125k of contribution used to purchase Life
  Insurance

Calculations provided by Pension Quote
21
Example 1 (continued)

• How?
• Comparability Testing
• Performed by TPA actuaries
• 25 of salary for 10 employees was already
  being contributed
• Percentage of salary required for contributions
  on behalf of rank and file employees can be
  different within limits

Calculations provided by Pension Quote
22
Example 2 Legal Eagle

• Multi-partner law firm
• 24 partners
• 30 associates
• 108 staff
• Total contribution to existing profit
  sharing/401(k) plan 1,712,000
• Total contributions for associates/staff
  632,000 (8 of companys associates/staff
  payroll)
• Total contributions for partners 1,080,000

• 63 of total contribution benefits the partners

Calculations provided by Pension Quote
23
Example 2 (continued)

• Solution
• Layer split-funded DB plan on existing plan
• New contributions
• Partners 3,552,000 . . . 2,472,000 increase
• Employee contribution 632,000 . . . no increase
  

Calculations provided by Pension Quote
24
Split-Funded DB PlansSummary

• Retirement income
• Life insurance protection
• Large tax-deductible contributions
• Customizable

25

• Transamerica Insurance Investment Group
  (Transamerica) and its representatives do not
  give tax or legal advice. This presentation is
  for informational purposes only and should not be
  construed as tax or legal advice. Clients and
  other interested parties must be urged to consult
  with and rely solely on their own independent
  advisors regarding the information and
  interpretations contained herein.
• The information presented here does not take into
  consideration the applicable state laws of
  clients and prospects. Although care has been
  taken in preparing this material and presenting
  it accurately, Transamerica disclaims any
  implied or actual warranties as to the accuracy
  of any material contained herein and any
  liability with respect to it. The information in
  this presentation is current as of March 2010.
• Transamerica Insurance Investment Group is
  registered with the National Association of
  State Boards of Accountancy (NASBA) as a sponsor
  of continuing professional education on the
  National Registry of CPE Sponsors. State boards
  of accountancy have final authority on the
  acceptance of individual courses for CPE credit.
  Complaints regarding registered sponsors may be
  addressed to the National Registry of CPE
  Sponsors, 150 Fourth Avenue North, Nashville, TN
  37219-2417. Telephone [phone]. Web site
  www.nasba.org.
• In the state of New York, Transamerica Life
  Insurance Company is an approved provider of
  continuing education courses (Provider
  Organization Approval Number NYPO-100366).

26
Life Insurance in Split-Funded Defined Benefit
Plans