1. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company1 What is it? Qualified plan purchases and owns life insurance on employee using deductible employer contributions to the plan to fund purchase

2. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company2 When is it indicated? large number of employees covered under qualified plan have unmet life insurance needs have gaps or limits on other company plans that provide death benefits want contribution option that would provide tax deduction when qualified plan is over funded or close to full funding limitation

3. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company3 When is it indicated? highly compensated plan participants face substantial estate taxes on death benefits life insurance could provide plan participants an additional option for investing their plan accounts employer wants secure funding vehicle for plan

4. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company4 Advantages favorable tax treatment as compared with individual life policies provided by employer outside qualified plan or personally owned life insurance safe investment predictable plan costs

5. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company5 Advantages retirement benefits guaranteed by insurance company as well as employer death proceeds less policy cash values (pure insurance portion of policy) not subject to income tax may be able to structure insured plan death benefits to avoid estate tax at participant’s death

6. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company6 Advantages exemption of fully insured from minimum funding standards and actuarial certification requirements reduces administrative costs and reduces complexity of defined benefit plan some life insurance companies provide low cost installation and administrative services if plan uses their investment products, further reducing cost

7. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company7 Disadvantages relatively low rate of return policy expenses and commissions may be greater than for comparable investments

8. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company8 How is it used? Insurance Coverage should provide for all plan participants under nondiscriminatory formula that is related to either –retirement benefit –plan contribution formula

9. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company9 How is it used? Insurance Coverage can condition coverage on medical exam IF this requirement does not discriminate in favor of highly compensated can minimize turnover costs with cash value insurance –make waiting period for insurance longer than plan’s waiting period for entry –use term insurance to cover interim

10. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company10 How is it used? How Much Insurance – The ‘Incidental’ Test IRS: any non-retirement benefit in qualified plan is incidental as long as cost of benefit is < 25% of total plan cost Difficult standard to apply

11. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company11 IRS has developed 2 practical tests 1.participant's death benefit must be no more than 100 times the expected monthly benefit 2.Aggregate premiums paid for participant’s insured death benefit are at all times less than these percentages of plan cost for that participant: “ordinary life” insurance 50% term insurance 25% Universal life25%

12. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company12 Life Insurance in Defined Benefit Plans adds to limit on deductible contribution in contrast, in defined contribution plan, life insurance costs must be part of contributions to each participant's account

13. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company13 Common ways life insurance is used in Defined Benefit Plans combination plan envelope funding fully insured plan

14. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company14 Combination Plan Retirement benefits funded with combination of –whole life policies –assets in separate trust fund (‘side fund’ or ‘conversion fund’) Approach combines advantages of –insured death benefit –investment security of policy cash values –aggressive investment of side fund assets

15. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company15 Combination Plan Appropriate for smaller pension plans (< 25 employees) Death benefit for each employee usually determined by 100-to-1 test Annual plan cost = required insurance premiums + amount deposited in side fund that is determined on actuarial basis

16. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company16 Envelope Funding Insurance policies simply considered plan asset Actuary determines total annual contributions to plan to provide retirement and death benefits under plan Employer makes contributions as determined by actuary Plan trustee purchases assets – including insurance policies – to fund cost of retirement and death benefits

17. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company17 Envelope Funding Keep amount of insured death benefit within incidental limits by – providing death benefit no more than 100 times each participant’s projected monthly pension or –keeping the amount of insurance premiums within appropriate percentage limits

18. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company18 Envelope Funding Requires lower initial contributions to plan than combination plan approach Long term costs depend on – actual investment results – policy dividends – benefit – administrative costs of the plan

19. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company19 Fully Insured Plans Funded exclusively by life insurance or annuity contracts Regaining popularity after pension investors lured away by high interest rates in 1970s and bull market of 1990s

20. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company20 Overfunding Problem for Qualified Defined Benefit Plans Tax deductible employer contributions –must meet actuarially determined minimum funding amount –cannot exceed “full funding limitation” Law limits interest rates that can be used in determining plan liabilities

21. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company21 A Solution – Fully Insured Plans [IRC Section 412(i) plans] Exempt from minimum funding rules Avoids overfunding problem

22. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company22 Plan is Fully Insured for Plan Year IF plan funded exclusively by purchase of individual insurance contracts contracts can be –individual or group –life insurance, annuity contracts or combination have level annual (or more frequent) premiums extending to retirement for each individual

23. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company23 Plan is Fully Insured for Plan Year IF plan benefits are equal to the contract benefits and guaranteed by licensed insurance company premiums paid without lapse or reinstated after lapse no rights under the contracts subject to security interest during plan year no policy loans outstanding at any time during plan year

24. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company24 Fully Insured Plans must be nondiscriminatory regarding –rights –benefits –features benefit formulas of plans satisfying safe harbor and specified uniformity requirements are considered nondiscriminatory in –contributions –benefits

25. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company25 Fully Insured Plans: Other Advantages simplified ERISA reporting requirements do not need certification by enrolled actuary reduced cost and complexity of plan administration exempt from requirement of quarterly pension deposits but subject to Pension Benefit Guaranty (PBGC) coverage and annual premium requirements

26. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company26 Fully Insured Plans: How Does it Work? can be used with new or existing plan employer can be corporation or unincorporated business typically uses group contract with individual accounts for participants

27. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company27 Fully Insured Plans: How Does it Work? insurance company guarantees all benefits premium based on guaranteed interest and annuity rates; conservative estimates results in larger initial deposits than in typical uninsured plan

28. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company28 Fully Insured Plans: How Does it Work? use of excess earnings to reduce future premiums means funding level high at beginning, resulting in –maximization of overall tax deduction –possibility of tax deduction for existing plan that has reached full funding limitation with uninsured funding

29. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company29 Life Insurance in Defined Contribution Plans part of each participant’s account can be used to purchase insurance on the participant’s life insurance purchase can be –voluntary –provided automatically as plan benefit –provided at plan administrator’s option (on a nondiscriminatory basis)

30. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company30 Life Insurance in Defined Contribution Plans insurance amount must be kept within incidental limits generally best to keep percentage contributions under full limits to maintain investment flexibility and employer ability to reduce contributions in lean years since IRS limit tests are computed in the aggregate, may be able to purchase a considerable amount of insurance in a later year

31. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company31 Life Insurance in Defined Contribution Plans in-service cash distributions allowed in profit sharing plans prior to termination of employment can be used without limit to purchase life insurance

32. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company32 Tax Implications 1.if amount of life insurance within incidental limits, employer plan contributions are tax deductible 2.economic value of pure insurance on participant’s life is taxed annually to participant at levels specified by the IRS; participant contributions are subtracted

33. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company33 Tax Implications 3.taxation of insured death benefit –pure insurance part is income tax free to plan beneficiary –total of all Table 2001 (formerly P.S. 58) costs paid by participant recovered tax free –remaining distribution taxed as qualified plan distribution

34. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company34 Tax Implications 4.insurance in a plan usually provides tax advantages not available for individual life policies provided by employer outside qualified plan or personally owned life insurance 5.may be possible to exclude insured portion of qualified plan death benefits from decedent’s estate for federal estate tax purposes

35. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company35 Alternatives 1.personally owned life insurance 2.group-term life insurance 3.life insurance financing in a nonqualified deferred compensation plan 4.split-dollar life insurance

36. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company36 True or False? 1.Life insurance provides one of the safest available investments for a qualified plan. 2.To be nondiscriminatory, the same amount of life insurance must be given to each employee. 3.Life insurance is advantageous in a defined contribution plan because it adds to the limit on deductible contributions.

37. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company37 True or False? 4.In combination plans, retirement benefits are funded with whole life and assets in a separate trust fund. 5.Fully insured plans must be nondiscriminatory with respect to rights, benefits, and features. 6.Split dollar life insurance is an alternative to life insurance in a qualified plan. 7.Life insurance can be used in a Keogh plan.

38. Life Insurance in a Qualified Plan Chapter 13 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company38 Discussion Question What are the considerations in determining whether fully insured funding is advisable from an economic, investment point of view?