Pre-Retirement Death Benefits in a NQDC

[Guest D Dell]

Is there any reason why a Non-Qualified Deferred Compensation Plan can not provide to the participant's beneficiary a pre-retirement death benefit defined as:

COLI death proceeds, less

Cumulative Employer Costs (lost tax-deductions from EE deferrals)

For example ER receives $500,000 death benefit, recovers its own "plan cost" of say $50,000, then pays $450,000 to the beneficiary. The $450k would be taxable to the beneficiary as ordinary income and tax-deductible to the Company.

Comments?

[mbozek]

The conditions for payment of NQDC is a matter of contract between the er and ee. Since the er gets to define the terms of the plan it can provide any benefit amount it wants to an employee.

[Kirk Maldonado]

But wouldn't you have current income taxation on the value of the death benefit coverage, a la split dollar arrangements? Look at Goldsmith v. Comm'r, 586 F2d 810 (Ct.Cl. 1978).

[E as in ERISA]

I would have said the same thing as mbozek -- because there is a difference between the taxation of the benefits under (a) a NQDC plan which the employer is "funding" with insurance and (B) a standalone insurance arrangement which is more directly affected by the COLI and/or split dollar rules.

[mbozek]

Kirk: I thought the Goldsmith case was anomalous and not followed by the IRS in subsequent plrs issued after the case was decided see 9617019, 9510009, 7940017 .

[Kirk Maldonado]

I couldn't locate PLR 7940017, but I don't think that the other PLRs stand for the proposition that you cite them for.

Both 9617019 and 9510009 expressly state that the plans provide retirement benefits. True, the benefits may become payable upon death (because death definitely is a termination of employment), but that is not the same thing as providing life insurance coverage.

I don't know that you definitely would be taxed on the value of the life insurance coverage, but there definitely is a risk of that.

[mbozek]

I thought that Goldsmith had several facts which made it distinguishable such as a provision in the employee's employment agreement which provided that the employer would pay the LI premium on the employee's life (by a reduction in the ee's salary?)which the ct said was no different that if the er paid the employee who then would make the payment. In the deferred comp type plan there are two separate contractual relationships 1) between the LI company and the employer for payment of the proceeds and 2) between the employer and employee under the DC plan. The LI proceeds are fungible as general assets of the er which can be used for any corporate purpose which is consistent with the PLRs cited (by the way there are at least 9 more rulings out there).

[Guest EAKarno]

If the employee's beneficiary is a direct beneficiary of the policy (i.e., endorsement split-dollar) then there would be an economic benefit from the coverage to be taxed but the death proceeds would be tax-free. If the death benefit is merely an unsecured promise to pay (i.e., a death benefit only plan), there is no economic benefit for the "coverage" and the death proceeds will be taxable as IRD. The COLI proceeds to the company are still tax-free and then deductible when paid to the beneficiary -- in most cases the employer would "gross-up" the payment for the IRD and come out even on an after-tax basis.

[Guest Harry O]

I'd be interested in the analysis that shows that the employer would be better off using COLI as described versus not buying insurance and simply paying the death benefit out of general assets . . . One has to assume that the employer can earn more with the money by reinvesting it in the business (after-tax) versus paying it to an insurance company (even though earning tax-free rates of return). If the employer can't, it might as well shut its doors, liquidate and invest all the assets in life insurance policies. Seem like shareholders would be better served . . .

[Kirk Maldonado]

EAKarno:

It is not completely true that the employer receives the proceeds tax-free. Those amounts are subject to AMT. That can be very important for some clients.

[Guest EAKarno]

Kirk,

You are correct, AMT must be considered. That, however, is why COLI is very rarely utilized by companies that expect to be at or near the AMT threshhold.

Harry O,

The initial analysis would focus not on whether to buy COLI or to pay out of general assets. The issue is whether to informally fund nonqualified liabilities at all. Once the company decides to do so, then the question is whether it makes more sense to use COLI or some other financial vehicles. Besides the tax advantages COLI may offer some companies, it also offers a hedge against premature death benefit liabilities.

[Guest Harry O]

Point well taken. But I am rarely convinced it makes sense to take money out of your business to fund something you don't have to. And you are right that insurance is a better bet in the case of premature death.