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419(e) welfare benefit plan deduction limit (life insurance only plan)


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For plans subject to 419(e) deduction limits, it is understood that the deduction is limited to the "qualified cost", where such cost is computed as the level premium for the death benefit coverage of a life insurance policy.

The question is when determining the qualified cost, is it necessary to compute the death benefit based on the guaranteed policy rates or the assumed policy rates?

With the assumed rates the death benefit is higher or the coverage extends to an older age, due to the greater return on the investment.

The guaranteed v. assumed rates are shown in the policy illustrations.

Thanks.

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Term insurance seldom has "guaranteed policy rates" and "assumed policy rates". 419(e) does not permit tax-deductible premiums to an insurance policy for cash value buildup; it only permits the current cost of coverage to be deducted. That cost of coverage may be determined in any number of reasonable ways including: (1) using actual term premiums; (2) using theoritical term premiums; (3) using a portion of the permanent insurance premium that represents the current term portion (such as under a split-dollar arrangement), etc.

The only deduction available for life insurance in excess of the current term cost is under 419A, and is limited to an annual amount to provide a paid-up policy of $50,000 or less at the participant's retirement date.

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vebaguru:

I have a question regarding this general topic. A bit off the topic but not too much.

My impression is that these limits are so stringent that you don't get much of an advantage out of pre-funding using an arrangement subject to these rules. I'm not saying you don't get any advantage, just that it isn't enough to be a big deal.

Stated in a different way, these limits restrict the deduction so much that these vehicles aren't attractive tax shelters to small businesses that are looking to shelter a lot of money.

I'm interested in your thoughts as to whether my perception is correct or not.

Kirk Maldonado

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Referring to vebaguru's response:

My understanding is that the amount deductible as a employer business expense is the "qualified cost" under 419(e) and that cost is the portion of the premium that provides for the death benefit coverage, thus the remaining portion of the premium is not deductible as a business expense, but is actually compensation to the employee, and essentially provides for cash value build up in the case of a cash value policy.

And the qualified cost is determined to be the level premium to provide for the death benefit coverage.

With that said, my question focussed around what should be considered the death benefit? Should it be based on 1) the death benefit when the policy is purchased, 2) the death benefit provided based on the guaranteed rates or 3) the death benefit provided based on the assumed rates in the illustration, where the present value of the level premium Pa (premium times life annuity factor) is equal to the present value of the death benefit, computed as a summation of the present value of the death benefit in each year (thus it can be based on the death benefit provided for each individual year, whether it stays the same or changes).

Thanks.

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If a plan were limited to Section 419 deduction amounts ("qualified" or current costs), it would not be worth it. Besides, anything that can be done in a welfare benefit plan under IRC 419 can be done directly by the employer.

Under 419A, however, qualified additions to a qualified asset account are permitted. Those amounts may range from inconsequential to substantial. For example, I recently assisted an insurance company to establish a VEBA for funding health benefits for retired employees. They were able to make a (one-time) tax-deductible contribution of $3,000,000 in the first year to fund those liabilities.

Even smaller companies may be able to realize a significant benefit from pre-funding both life and health insurance benefits. Although 419A(e)(2) limits the amount of post-retirement life insurance that can be pre-funded, nothing prevents an employer from obtaining a tax deduction for handing an employee a paid-up policy for $1,000,000 or more. That would give the employer a substantial tax deduction in the year of retirement. However, because that would be a form of deferred compensation, the plans we administer do not premit the transfer of the insurance policy. (Policies held in the WBP after a participant's retirement continue to provide tax-free death proceeds under IRC 101(a), but are not subject to the Table I reporting requirements.

Sometimes such plans are worth it, sometimes not. We can't tell without running out the numbers. However, the primary factor that determines whether such plans are beneficial is the cost of covering rank and file employees.

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Thank you for the responses.

However, I am not quite seeing how vebaguru's response answers the question I posed in my prior post.

Perhaps, it would be helpful if you read my prior post based on an assumption that I am referring to a one-life life insurance (with cash-value build up) welfare benefit plan for a single employer where I believe that the employer deduction for expense is the qualified cost, which is subject to 419(e).

And in determining the value of the death benefit being provided, which is computed as an actuarial level premium for the death benefit only, thus not the same as the actual life insurance premium, do I want to base the actuarial level premium calculation on the death benefit under the 1) assumed illustration, 2) the guaranteed illustration, the 3) the death benefit at the time the policy commences, or 4) another amount?

Thanks.

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Gary-

My answers were directed primarily toward Kirk. Sections 419 and 419A limit tax deductions; they do not authorize them. Section 419(e) simply defines the terms "welfare benefit", "fund" and "welfare benefit fund". Read IRC sections 419 and 419A.

The qualified cost is the ratable portion of the current death benefit coverage without cash-value build up. This can be accomplished through term insurance or a split dollar approach.

To the extent that a welfare plan provides more than a current death benefit (as represented by cash-value build up), the contributions for that portion of the benefit are limited by Section 419A which permits qualified additions to a qualified asset account.

The largest death benefit that can be pre-funded through qualified additions to a qualified assets is $50,000, per IRC 419A(e)(2). To answer your question directly, therefore, in addition to paying the current term insurance charges on the entire amount of coverage, it is possible to tax-deduct an actuarially-determined level contribution amount sufficient to provide a paid-up death benefit of $50,000 at the participant's normal retirement date.

Some insurance companies have software that can illustrate this deduction amount. (It could be argued that an amount is "actuarially determined" if it comes directly from the rates of the insurance company that were determined by the company's actuaries.) The way to prepare this illustration is as follows:

1. Determine the plan's formula and death benefit amount.

2. Run a ledger on the policy showing that face amount as being in force from the issue age until the participant's normal retirement age.

3. Have the policy reduce to $50,000 at the participant's normal retirement age.

4. Tell the software to calculate the level premium payable from the current age to the normal retirement age.

My guess is that you will be very disappointed in the results. It will be possible to deduct only a portion of the total UL premium. Only through using a blended rate (the blend will vary by age, but start with 80% term) will you be able to find a premium which accomplishes your objective and is fully deductible within the limitations provided under IRC sections 419 and 419A.

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