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B21

cash balance with life insurance

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I understand that if a cash balance plan (or any defined benefit plan) permits the purchase of life insurance policies that this benefit has to be offered to all participants to satisfy the nondiscrimination requirements. Does this mean a policy has to be issued on behalf of each eligible participant or only that the participant has to be provided the option to have a life insurance policy purchased on their behalf? I thought, unlike a defined contribution plan, a participant cannot make an election to include a life insurance policy in a defined benefit plan.

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Short answer, it depends.  How is the CB plan itself passing non discrimination testing?  

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In a Defined Benefit Plan that permits a survivor benefit funded with life insurance the benefits, rights and features must be available on a nondiscriminatory basis.  

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The policies will be made available to all eligible participants both highly compensated & nonhighly compensated. Therefore, this would pass the 410(b) ratio test for BRF.

Am I correct?

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17 hours ago, ErnieG said:

In a Defined Benefit Plan that permits a survivor benefit funded with life insurance the benefits, rights and features must be available on a nondiscriminatory basis. 

But what does "available" mean in that context?  It's either in the plan or not ("insurance benefits are X times monthly benefit").  I don't see any participant discretion there, except perhaps by refusing to complete an app.

I am curious as to how this would work in a CB plan (i.e. "offered" or mandated).  Seems like DB concepts should apply.  Personally I don't like insurance in plans but was asked this very Q and appreciate any insight.

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1. The employer pays the premium, therefore what is there not to accept (other than PS-58 costs)?

2. As shERPA implied, if the CB passes nondiscrimination testing on a stand alone basis (which is rare), the rules would be similar to a regular DB plan, but if it is aggregated that usually means NHCEs get more in the DC plan, so that has to be taken into account to determine whether the insurance is discriminatory, i.e. insurance levels compared to benefits from both plans.

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3 hours ago, B21 said:

The policies will be made available to all eligible participants both highly compensated & nonhighly compensated. Therefore, this would pass the 410(b) ratio test for BRF.

Am I correct?

Not really.   In a true DB plan the employer pays the cost of the ancillary death benefit, it does not reduce the normal retirement benefit.   So there really isn't any "election" to be made.   Why would employees opt out of a free (to them) benefit?   

DC plans are different - the premium comes out of the account, so the participants pay the cost of the death benefit in a reduced retirement benefit.  Here there is a valid choice to be made by participants.  

Death benefits have to be non-discriminatory.  If they are a function of the retirement benefits that are also non-discriminatory, all's well.  So the death benefit (e.g. 100x the monthly benefit) is non-discriminatory in a DB providing non-discriminatory retirement benefits.

But now, suppose the DB plan is tiered - 415 max to owner, 0.5% benefit to NHCEs, then paired and tested with a DC plan for non-discrimination.  The DB benefits are discriminatory on their own, that's why it's aggregated with the DC plan.  So if a death benefit (100x for example) is provided in the DB plan only, the death benefit is also discriminatory.  If the NHCEs death benefit that would be non-discriminatory is provided in the DC plan, that's a problem too because it reduces the projected retirement benefit in the DC plan.   If the DB plan provides a death benefit that would be non-discriminatory based on some theoretical non-discriminatory retirement benefit that the DB plan doesn't actually provide, then the DB plan likely blows the incidental limitations.

CBs are typically a variation of this tiered DB.  The CB benefits themselves would be discriminatory, so any death benefits that were just a function of the CB retirement benefits would also be discriminatory.  If the CB is stand alone, then the death benefits would be non-discriminatory but again, the CB is a DB plan so the death benefit is employer-paid, so giving employees an opt-out for a free benefit is a non-starter.

Now there are lots of ways that some try to beat insurance into the plan using a "if it doesn't fit get a bigger hammer" approach.  Some say giving ees the "option" for insurance in the DC plan works - I don't see how.  Others figure out how much the death benefit needs to be in order to be non-discriminatory, then put it in the DC plan but also increase the ER contribution to the ees in the DC plan to cover the additional cost of the death benefit without reducing the retirement benefit needed to be non-discriminatory.   In a theoretical sense this might work, but I can't imagine a TPA being able to make a profit on this unless they are getting a commission split.  The fee-based market does not support the fees that would be necessary to adequately compensate us for this amount of brain trauma each year.  

I imagine there are a few other approaches as well.   For my own practice, retirement plans are complex enough as they are, I don't need to find ways to complicate them further, and I've never seen an rigorous economic analysis demonstrating the benefits of having life insurance in the plan.   So I choose not to go here. 

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I, personally, agree with shERPA. The one little niggling memory I have on this issue is that I attended a Q&A at an ASPPA Annual Conference (where Larry Starr was sitting next to me, so I know he heard it, too) where Kyle (Brown?) from the IRS made a clear and unequivocal statement that one looks solely at the DB plan in this circumstance.  I think, after hearing the comment, Larry went to the microphone to convince Kyle he must have misunderstood the question.  Kyle just shook his head and reiterated his position.  Not formal authority for sure but at least food for thought. 

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"Why would employees opt out of a free (to them) benefit?" Well, it ain't necessarily "free" as there is generally current income that must be declared on the taxable term cost. Particularly at older ages, this can be substantial, depending upon your definition of "substantial." 

Avoiding the general insurance vs. no insurance debate, I'll just observe that some participants do not want to pay the taxable term cost, as they either don't want insurance, have sufficient insurance (by their reckoning) outside of the plan, etc. - so there are valid reasons for a participant not to want insurance in a DB plan.

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Assuming that the participant declines to have insurance, how does a DB plan cover coverage and BRF issues - not get any coverage?

One way to do is just simply get the insurance (assuming no tests are required). Of course the employee may choose not to sign any forms.

Bonus question: Owner is healthy and wants insurance in the DB plan. 2 out of 3 rank&file employees are not insurable due to health reasons. What to do? Rely on average benefit percentage test based on accruals?

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5 hours ago, Belgarath said:

there are valid reasons for a participant not to want insurance in a DB plan.

True enough.  But if an IRS auditor comes across a DB or CB plan where every participant except the owner has "voluntarily waived" the insured death benefit, the question of BRF effective availability will be front and center, with the burden of proof on the employer. 

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On 1/20/2020 at 9:24 AM, Jakyasar said:

Bonus question: Owner is healthy and wants insurance in the DB plan. 2 out of 3 rank&file employees are not insurable due to health reasons. What to do? Rely on average benefit percentage test based on accruals?

Usually, the plan document will state what happens if a participant should be rated beyond a certain point or uninsurable. For example:

For a Participant who is found by the Insurer to be insurable only at a mortality classification other than standard, the Trustee (or Insurer)s on a uniform and nondiscriminatory basis shall either (1) purchase an insurance Contract with a face amount that can be purchased at the standard rate for coverage as provided in Plan Section 5.9(a) for such Participant if such coverage could be obtained, (2) purchase such insurance Contract and pay the additional premium attributable to the excess mortality hazards, or (3) allow the Participant the right to pay the additional premium attributable to the excess mortality hazards. If a Participant is determined to be uninsurable, or if the Participant refuses to comply with the requirements of the Insurer, no life insurance Contract shall be required to be purchased on the life of such Participant.

But, I too, am facing a similar situation. A takeover DB plan that is tested with a DC plan. There are participants in the DC plan who are not in the DB plan. The question is how (or if we do) we provide an insured death benefit on a nondiscriminatory basis. I like the idea of calculating the amount of insurance to be purchased for each participant and then, to the extent their benefit is not provided in the DB, to purchase term insurance in the DC as an additional contribution. This keeps the purchase away from the individual accounts while providing the pure death benefit necessary to be non-discriminatory. Because, these participants are likely NHCEs, adding this contribution cannot be seen as discriminatory.

Any further thoughts or direction to guidance?

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I believe that you would need to have the same policy types (i.e. same policy series of Life Insurance for HCEs and NHCES) to satify the nondiscriminatory availability of benefits, rights and features (See Rev. Rul 2004-21).  In other words, you would have two separate BRFs to test for current and effective availability if you have two different types of life insurance in the plan.

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What is that belief based upon? We are talking about merely an insured death benefit. What effect does it have on BRF to a participant who has one type of policy or another? I contend it only has to do with the enhanced death benefit.

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2 hours ago, Dalai Pookah said:

What is that belief based upon? We are talking about merely an insured death benefit. What effect does it have on BRF to a participant who has one type of policy or another? I contend it only has to do with the enhanced death benefit.

SRM cited RR 2004-21 for you.  IRS looks at things like "purchase rights" as separate BRFs. 

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Unfortunately, Rev. Rul. 2004-21 begs the question to come to the result:

"the features of the life insurance contracts covering the lives of highly compensated employees are different than the features of the life insurance contracts covering the lives of nonhighly
compensated employees. In addition, because of these differences in the features of the contracts, the rights that the nonhighly compensated employees have to purchase the life insurance contracts under which they are insured from Plan A are not of inherently equal or greater value than the rights that highly compensated employees have to purchase the life insurance contracts under which they are insured."

I would contend that if any employee had the right to purchase his or her contract from the plan under the same conditions, the type of the contract is irrelevant. A term contract is no different from a whole life (or universal) except for the fact that it has no CSV.

In a DB plan, it is benefit neutral--taking the insurance out of the plan does not change the accrued benefit and some of the value of the accrued benefit is incorporated in the CSV.

With respect to a DC plan, again the whole life contract has cash value (again part of the benefit), however, inherently that participant's account has been diminished to a larger degree representing the larger relative premium. The participant with term insurance has seen his or her account diminished less and therefore has a larger account balance as a result.

So long as the participant has the right to purchase whatever policy is in the plan, I would argue there is no differentiation in BRF and therefore no discrimination.

There is no analysis in the Rev. Rul. defining what these differences are or what the value is. I could argue that having to pay little or nothing for coverage for the remainder of the year is more valuable than paying a substantial amount for the right to have a level premium in the future. Theoretically, I believe the equations are equal (even in the varied marketplace, they may not be). If the premise, however, is that the rights are less valuable for the NHCEs, then you can arrive at no other conclusion. 

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You could so argue. Don't think you would prevail, though.

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"Unfortunately, Rev. Rul. 2004-21 begs the question to come to the result:"

Holy Shoot (check the George Carlin translation)!  Did someone really use "begs the question" correctly? I am delighted, encouraged, gratified, amazed, and reassured about humanity.  I am too lazy to check Rev. Rul. 2004-21 to confirm, but it appears that Dalai Pookah nailed it, or at least put the phrase in a context that looks correct.  No comment on substance, but the rhetoric is soooo refreshing.

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I agree with Mike, and others before him. I think Dalai is focusing merely upon the "purchase right" which is NOT the only issue. If you have different types of policies, there are distinct BRF's (or let us say there are LIKELY to be different BRF's). And these have to be tested. If you've ever studied the terms of different life insurance contracts available from the same or different insurers, I'd say the odds of finding identical provisions in all circumstances are, to put it mildly, rather poor.

Just my humble opinion.

Excerpt from the RR below.

"Similarly, differences in insurance contracts (e.g., differences in cash value growth terms or different exchange features) that may be purchased from a plan can create distinct other rights or features even if the terms under which the contracts are purchased from the plan are the same. Under § 1.401(a)(4)–4(d)(4), an optional form of benefit, ancillary benefit, or other right or feature is permitted to be aggregated with another optional form of benefit, ancillary benefit, or other right or feature if one of the two is, in all cases, of inherently equal or greater value than the other, and the optional form of benefit, ancillary benefit, or other right or feature that is of inherently equal or greater value separately satisfies the current availability requirement of § 1.401(a)(4)–4(b) and the effective availability requirement of § 1.401(a)(4)–4(c). For this purpose, one benefit, right, or feature is of inherently equal or greater value than another benefit, right, or feature only if, at any time and under any conditions, it is impossible for any employee to receive a smaller amount or a less valuable right under the first benefit, right, or feature than under the second benefit, right, or feature."

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18 hours ago, Dalai Pookah said:

So long as the participant has the right to purchase whatever policy is in the plan, I would argue there is no differentiation in BRF and therefore no discrimination.

As Mike says, of course you can so argue.  And in an after-the-fact situation you’d be remiss not to. 
 

But is it reasonable to knowingly put a client in a place where making such arguments may become necessary?  What’s the benefit to the client that justifies the cost and the risk?

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What’s the benefit to the client that justifies the cost and the risk?

I will agree to disagree with the discourse above. the benefit to the client is that as a fiduciary he is not wasting plan assets on long-term insurance contracts for the benefit of largely non-long-term employees. Belgarath makes the point that the odds of finding identical provisions in different contracts rather poor. So, this escalates the question to not be limited by whole life/term, but rather if I buy contracts from two different companies or if the original contracts are not being offered by the same company. Someone may want to split hairs on a specific provision, but if we could treat the essence of life insurance as fungible, then it is hard for me to see, practically, what the offending BRF might be. Thanks to all for the insight.

Thank you to QDROphile for the compliment.

Moving on to a thornier issue in the same vein, in a combo CB/401(k), could the insurance be purchased in the DB plan for all participants, even though not all employees participate in the CB plan? This would avoid the issue of creating a separate insurance premium bucket in the DC plus taking into account that most DC documents do not handle this situation elegantly (neither do most DB/CB documents). If we had to draft individually designed language, where would you go.

To complete the circle, could you freeze the purchase of new policies at any point (could raise discrimination issues) or would a plan have to divest itself of the insurance?

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1 hour ago, Dalai Pookah said:

I will agree to disagree with the discourse above. the benefit to the client is that as a fiduciary he is not wasting plan assets on long-term insurance contracts for the benefit of largely non-long-term employees.

Moving on to a thornier issue in the same vein, in a combo CB/401(k), could the insurance be purchased in the DB plan for all participants, even though not all employees participate in the CB plan? This would avoid the issue of creating a separate insurance premium bucket in the DC plus taking into account that most DC documents do not handle this situation elegantly (neither do most DB/CB documents). If we had to draft individually designed language, where would you go.

To complete the circle, could you freeze the purchase of new policies at any point (could raise discrimination issues) or would a plan have to divest itself of the insurance?

1.  OK, I understand not buying long term contracts on ees who are short term, that is a waste.  But what's the compelling benefit to the owner or other HCE of life insurance in the plan vs buying insurance outside of the plan?  Yes, I know the "buying with pre-tax dollars" argument, but they still have to pay tax on the annual term cost, so it's not tax free.  And the internal policy growth is just another plan investment with high expenses. 

2.  How, without violating the incidental limits?

3.  Sure, as long as the insured group passes 410(b).  Wouldn't do so for long assuming turnover.   

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1 hour ago, Dalai Pookah said:

in a combo CB/401(k), could the insurance be purchased in the DB plan for all participants, even though not all employees participate in the CB plan?

I don't see how this could be okay. Plan assets must be used solely to provide benefits to participants and their beneficiaries (or to defray reasonable expenses). You can't use assets to provide insurance for someone who isn't a participant in that plan.

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