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retbenser

Incidental Death Benefit

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One-participant plan

TNC = $100,000 and FT = $200,000

Projected monthly benefit at NRA = $16,250 (415)

Death Benefit = AE of accrued benefit at death

Funded (partially) with Variable Universal Life; Death Benefit = $3,000,000 and Annual Premium = $30,000

Cash Value = $40,000 and Cash surrender value = $0

(a) Any problem with incidental death benefit if total contribution = $70,000 (trust) + $30,000 (insurance) = $100,000? What is procedure for testing?

(b) What is asset? CV or CSV?

Thanks.

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I have done lots of one-participant plans, but have no idea what you mean by TNC and FT. Total normal cost and free throws are my best guess.

Apparently the earned income is greater than $195,000, since that is the given 415 limit.

How can the death benefit be both the "AE of accrued benefit at death" and $3,000,000?

The maximum incidental death benefit is determined under several alternative rules. The basic rule is the 100 to 1 rule, which would indicate that the participant could have a death benefit of 100 X the monthly pension benefit of $16,250, for a total insured death benefit of $1,625,000. Your plan fails this test.

The second test is simple and straightforward. Up to 50% of the contributions may go toward the purchase of whole life policies, or up to 25% of the contributions may go toward the purchase of term or universal life policies. Your plan also fails this test.

A third test available is available under RR 74-307. Under that test, 2/3 of the actuarially-based contribution may go towards whole life insurance premiums, or 1/3 toward the purchase of universal life. Your plan also fails this test.

(b) What is asset? CV or CSV?

IRS likes the greater of the sum of premiums paid or the surrender value.

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I have done lots of one-participant plans, but have no idea what you mean by TNC and FT. Total normal cost and free throws are my best guess.

Apparently the earned income is greater than $195,000, since that is the given 415 limit.

How can the death benefit be both the "AE of accrued benefit at death" and $3,000,000?

The maximum incidental death benefit is determined under several alternative rules. The basic rule is the 100 to 1 rule, which would indicate that the participant could have a death benefit of 100 X the monthly pension benefit of $16,250, for a total insured death benefit of $1,625,000. Your plan fails this test.

The second test is simple and straightforward. Up to 50% of the contributions may go toward the purchase of whole life policies, or up to 25% of the contributions may go toward the purchase of term or universal life policies. Your plan also fails this test.

A third test available is available under RR 74-307. Under that test, 2/3 of the actuarially-based contribution may go towards whole life insurance premiums, or 1/3 toward the purchase of universal life. Your plan also fails this test.

(b) What is asset? CV or CSV?

IRS likes the greater of the sum of premiums paid or the surrender value.

Thank you. FT = Funding Target; Plan death benefit = actuarial equivalent of accrued benefit; Insurance death benefit = $3M

So here are 3 solutions:

(a) Limit the insurance death benefit to 100xprojected monthly benefit and adjust the premium accordingly:

New Premiium = 1.625M / 3M) x 30,000 = $16,250

Trust Contribution = 100,000 - 16,250 = $83,750

(b) Restrict premium to 25% of total contribution

Premium = .25 x 100,000 = $25,000

Trust contribution = $75,000

© Restrict premium to (1/3) of Individual level premium (without pre-retirement benefit)

Assuming ILP premium = $25,000

Premium = 1/3 x 25000 = $8,300

Trust contribution = $91,700

The option that gives the largest premium is (b).

So I will PASS the incidental death benefit test if: Premium = $25,000 and Trust contribution = $75,000 and Death Benefit = $1,625,000

That's it?

Thanks again.

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Just so I understand, does your $100,000 TNC include the $30,000 premium? Is the $30,000 the pure cost of the insurance or does it have an investment component in it?

"The option that gives the largest premium is (b)." Is the amount of the premium flexible? I don't understand how one option could produce a larger premium? Isn't the premium the premium?

You gave your TNC & FT, but not the assets or the shortfall. Are you including the CV in your assets?

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Just so I understand, does your $100,000 TNC include the $30,000 premium? Is the $30,000 the pure cost of the insurance or does it have an investment component in it?

"The option that gives the largest premium is (b)." Is the amount of the premium flexible? I don't understand how one option could produce a larger premium? Isn't the premium the premium?

You gave your TNC & FT, but not the assets or the shortfall. Are you including the CV in your assets?

The $100,000 does not include the premium. It is the TNC using PPA assumptions with no pre-retirement decrements. The $30,000 premium includes both pure insurance cost and an investment component.

CV = $40,000 CSV = $0 Premiums paid = $65,000

I am tempted to include in assets 70% of CV, reflecting RP 2005-25 (where market value = PERC x average surrender factor (which is at least 70%))

My question is: how do you comply with incidental death benefit rule post-PPA given the above situation?

Thanks.

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I think you might have several issues with your funding, even though you didn't ask about that. The TNC should include an expense for the cost of the death benefit - this is generally NOT the premium, but it should be something. In other words, if your TNC doesn't include the expense, than it isn't really a TNC. You might want to look at these past threads.

http://benefitslink.com/boards/index.php?s...nce+PPA+funding

http://benefitslink.com/boards/index.php?s...nce+PPA+funding

Anyway, to answer your question I wouldn't go past 100X projected. Anything else in the post PPA world leads to potential fights related to interpretations of the law, and in general the IRS had deeper pockets and more incentive to win.

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I think you might have several issues with your funding, even though you didn't ask about that. The TNC should include an expense for the cost of the death benefit - this is generally NOT the premium, but it should be something. In other words, if your TNC doesn't include the expense, than it isn't really a TNC. You might want to look at these past threads.

http://benefitslink.com/boards/index.php?s...nce+PPA+funding

http://benefitslink.com/boards/index.php?s...nce+PPA+funding

Anyway, to answer your question I wouldn't go past 100X projected. Anything else in the post PPA world leads to potential fights related to interpretations of the law, and in general the IRS had deeper pockets and more incentive to win.

Thanks for the response.

I am trying to understand how to implement the incidental rule in the PPA era.

Here is how I understand the rule works:

Before PPA, deductible contribution is the balancing item;

total deductible contribution = trust contribution (funding assumptions) + premium (premium satisfies incidental rule)

After PPA, trust contribution becomes the balancing item;

trust contribution = total deductible contribution (using PPA assumptions) - premium (premium satisfies incidental rule)

Post-PPA:

(a) Total deductible is determined using PPA rules and assumptions

(b) Deductible insurance premium is limited by the "incidental" rule

© Trust or side-fund contribution is the residual item

Is this correct or am I missing something?

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Sorry, I feel like I'm on a different boat. Maybe someone else can chime in. I'm confused by your use of the term "balancing item"? What are you balancing?

My thought is post PPA the TNC needs to include some expense for the cost of the death benefit. As I said, this is NOT the premium amount since the premium has an investment component in it. I don't think the FT includes any of the value of the insured death benefit since it is not a liability the plan will pay and is covered by the insurance. Therefore the only impact of insurance is a higher TNC.

I think the main question is how do you handle the cash values. I believe the consensus is that you add the market value of the insurance (cash surrender value?) to the trust assets and those are your assets used to determine your minimum and maximum contributions.

In other words, the min/max should be the same regardless of whether the policies are term, whole life or universal life. The cost of the death benefit is the same, the only reason the premiums are different is due to the investment component of the policy. Therefore, you need to break out everything other than the cost of the death benefit and treat it like an investment, not a cost.

The incidental death benefit rules didn't change when PPA was past. They are not impacted by the PPA funding rules. Keep it to the 100X and you won't have any trouble. If you are trying to pound a square peg into a round hole to "sell" more insurance, I can't really help you.

Maybe Ned will chime in and give you a few tips.

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My thought is post PPA the TNC needs to include some expense for the cost of the death benefit. As I said, this is NOT the premium amount * * *"

This is correct. There are 2 choices: (1) a one-year term cost that is added to the normal cost, representing the cost of term insurance for the year, or (2) a split funded valuation where the retirement benefit is split into 2 pieces, the portion represented by the cash value of the insurance police at retirement (the normal cost of which is the current year premium) and the balance, for which the normal cost is actuarially determined.

I think the main question is how do you handle the cash values. I believe the consensus is that you add the market value of the insurance (cash surrender value?) to the trust assets and those are your assets used to determine your minimum and maximum contributions.

You are correct that the "value" of the insurance is added to the assets in the case of OYT costing (although the surrender value may be inappropriate with some policies).

In other words, the min/max should be the same regardless of whether the policies are term, whole life or universal life. The cost of the death benefit is the same, the only reason the premiums are different is due to the investment component of the policy. Therefore, you need to break out everything other than the cost of the death benefit and treat it like an investment, not a cost.

Again, you are correct for those using the OYT method.

The incidental death benefit rules didn't change when PPA was past.

The incidental death benefit rules didn't change when PPA was passed.

Keep it to the 100X and you won't have any trouble.

I disagree. This is akin to "avoid permitted disparity and you won't have any trouble". There are alternative rules supported by most software systems. Run the tests all 3 ways and use the one that is in the employer's best interest.

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The incidental death benefit rules didn't change when PPA was past

I guess I slipped into a prophetic trance and was channeling a response from sometime in 2014 :rolleyes:

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I have done lots of one-participant plans, but have no idea what you mean by TNC and FT. Total normal cost and free throws are my best guess.

I am sad to see that your normally useful comments are now tainted. We have had these concepts and labels around for several years now, so your observations look like instructions for tuning up a 20 year old car.

My read on the incidental death benefit rules is similar to one Mike Preston published recently. One of the options was the 25% rule for plans that were not "ordinary insurance", and 50% for "ordinary" or level premium cash value policies. It was grounded in the concept of the individual level premium cost method, which is no longer a part of the funding method.

The 73-407 rules were not developed to reflect a unit credit funding method, which might include current accruals or not, and which might include a past service component. Neither of those two items will produce a consistent level premium cost. It's like comparing apples and kangaroos.

A plan can have target normal costs that vary widely based on compensation and plan benefit accrual patterns, such as the top-heavy formula that stops at 10 years. A plan can have wide fluctuations in past service costs based on asset values that fluctuate 20% year by year. These are not a rational basis for determining whether insurance values are incidental.

The IRS needs to address this issue again with PPA in mind, but in the meantime, you should apply either the 100 times rule or the 25%/50% rate on individual level premium calculations that are not part of the required funding rules for IRC 430.

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This is how I understand the incidental rule to work post-PPA.

Let's say the sponsor wants to contribute and deduct the maximum contribution.

And let's say the sponsor elects to include the life insurance in both the assets and liabilities (FT and TNC)

Step 1: Determine the max contribution using PPA assumptions (segment rates, cushion, etc ...). Let us say maximum = $1M

Step 2: Determine if the life insurance premium satisfies the 2/3 OR 100x rule. Let us say the premium is $400K and satisfies the 2/3 rule

Step 3: The sponsor can then deduct the full premium ($400K), contribute and deduct $600K to the side-fund trust, and includes the entire CSV or CV in the assets.

However, if the insurance fails the incidental rule, then the actuary must determine what portion of the premium satisfies the incidental rule.

Let us say of the $400K premium, only $300K is considered incidental.

Therefore, the sponsor can deduct only $300K of the premium and contribute and deduct $700K to the side fund, and include only a portion of the CSV or CV in the assets.

Is this how the incidental rule work? We are to limit the deductible premium (so that it is incidental). However, the total deductible amount is determined using PPA assumptions and independent of the premium.

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ret... do you determine that the death benefit is incidental because the face amount and/or level premium cost is in the proper range first? If so, then I agree.

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My oh my.

SoCal, maybe veba is quoting the rules for a multi-employer plan. Or, it is very possible that the "old" calculations will always result in a contribution which fits within the new rules on the cases that they have, so maybe somebody's internal instructions may have been: stay the course.

One general point of clarification: the cost of insurance, to the extent there is ANY, that is reflected in a valuation must be based on a coherent set of assumptions. Hence, unless you have a pre-retirement decrement, you don't have a "cost of insurance". Then, once you do decide to value the plan utilizing a pre-retirement decrement, you now have to follow the regulations as to how one values an ancillary benefit. Those rules are not trivial so I won't repeat them here. Besides, SoCal has heard me describe them in detail during a session at ASPPA last year so I'll pass the baton to him if he wants to lay them out. Suffice it to say that they are not terribly intuitive. The rules for calculation vary by whether the death benefit is a function of service or not. My guess is that "all the face amount we can possibly get with the maximum premium determined by application of the incidental benefit limitations" is NOT a service based benefit, but I'd have to read the regs again to be sure. As I said: not trivial.

ret: There is a disaster waiting to happen if I have understood what you wrote. You seem to be implying that the plan can purchase all the insurance that it wants, and the only ramification of having purchased "too much" are that the plan sponsor is limited to deducting only the amount that could have been purchased under the incidental benefit test. While what you have described may be theoretically possible if the plan document appropriately limits the death benefit to the participant so that the incidental limitations are satisfied, I can tell you from experience that the IRS doesn't like those provisions and they will therefore scrounge around for another reason, sometimes a far-fetched one, to make the plan sponsor's life miserable. And if the plan document doesn't pay homage to the incidental benefit limitations at all you have a complete disaster (disqualified plan).

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Guest Ned Ryerson
Maybe Ned will chime in and give you a few tips.

Yeah, I will give you some tips - BUY MORE INSURANCE! DUH!

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If the participant has insurance equal to 100x his benefit (or more) and he dies, who gets the non-insured plan assets, Ned?

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