Profit Sharing Plan & Annuities

[Guest Ddalk]

I have a potential client who has an existing discretionary profit sharing plan (restated 03/2002) with 1 HC and 14 NHCs, and offering life insurance to participants. The plan's annuity contract is not a group annuity but a single annuity where the HC is the annuitant. The annuity is held in an SEP IRA in the PSP's custodial account.

Question 1: Shouldn't the annuity be a group annuity instead of a single?

Question 2: Shouldn't the PSP's custodial account not contain an SEP IRA?

I could really use any applicable citations if any are available.

Thank you.

[mbozek]

SEPs are employer contributions to an IRA owned by the employee. See Pub 590, P 63. Since a SEP is not a qualified plan under IRC 401(a) the assets cannot be held as an asset in a ps plan. I never heard of an IRA issued to a qualified plan. There is something called an employer sponsored IRA Trust under IRC 408© but it is used mainly by unions.

The assets in the IRA would be limited to an indivudal annuity not a group annuity becuase the IRA must be owned by the individual. However it is unusual/cumbersome for a custodial account to own an annuuity contract because the IRA is tax deferred in an annuity.

[Guest Ddalk]

Thanks for the help MJB. I'd never seen an arrangement like this either. I belive the plan was set up this way by a financial advisor out of his element. I appreciate the citation.

[Guest Ddalk]

I still have a question about whether it's proper for a profit sharing plan to hold all Plan assets in an individual annuity, (not including the SEP feature), where the ER is the annuitant. Shouldn't multiple contracts or a group contract be used? I am finding little information on rules governing annuities in qualified plans.

[goldtpa]

Aside from the SEP-IRA issue, there is a fiduciary issue and a document issue. Does the plan document allow for the purchase of life insurance? Secondly I am not aware of any regulation that states what a fiduciary should invest in. Basically, your HCE must act solely in the interest of the plan. The question is whether investing in an individual annuity would be a breach of fiduciary responsibility under the prudent man rule. In order to satisfy the prudent man rule, one of the issues you must consider is the anticipated cash flows. In a business with high turnover, it would not be prudent to invest all of the assets in an individual annuity. In order to distribute the vested benefits to the employees, the HCE would have to withdraw money from the annuity thus incurring surrender charges. Also to satisfy the prudent man rule you must diversify your assets to minimize losses. Your HCE would have to prove that his investment strategy is reasonably designed to minimize losses and expenses, not to mention take advantage of opportunities to make money.

[Guest Ddalk]

Thank you for responding.

The plan does allow for the purchase of life insurance. I was hoping there existed some IRS guidelines on this subject for matters of personal edification because I am not well versed in insurance products utilized in such a manner. I am grateful for your analysis.

The reasons you've stated regarding the problems created by having an individual annuity (holding all plan assets) in a PSP are valid, as is your analysis of the fiduciary standard of the prudent person/investor.

I appreciate your help.

The only thing I would add is that the owner/HCE is not trustee of the Plan (a bank is), so I would think that the additional fiduciary diversification duties of ERISA sec. 404 would be imposed on the bank, and that the delegation of fiduciary duties would apply to HCE.