412i - the Next Generation ?

[JAY21]

This is partly commentary and partly a question. A financial advisor brought us a brochure from a firm touting a type of traditional defined benefit plan that "almost" gets contributions similar to a 412i plans, but with a 50-50 mix of trust investments (stocks, bonds etc...) and life insurance. The contributions to the trust are typical maximum DB contributions, plus there is an exact matching level of deductible contributions to purchase life insurance (i.e., total contribution double the normal max DB contribution level when life insurance premiums are considered). As best I can tell from the brochure commentary, it appears this is a response to recent IRS promulgations on 412i plans and valuation of insurance in general. As you would expect with this arrangement, it appears to be a split-funded DB plan, but the life insurance premiums appear heavily front loaded (they are payable for 5-years) and more important the death benefit appears to be far, far, in excess of the incidental death benefits even using the 2/3rds method. They name an individual person as the beneficiaries (not the plan/trust) so It appears all death proceeds go directly to a named beneficiary without restriction. Given the insurance premium is an exact match of an un-rounded DB contribution figure, it seems too coincidental to be anything but an intentional matching figure. I think they may be taking the old revenue ruling on insurance limit that states that 50% of the contribution can be used to purchase whole life insurance, and trying to apply that directly to a DB plan without using normal 2/3rds derivative of this limit. My question is, is it clearly established that the insurance limit Revenue Ruling (50% method) only applies to DC plans and cannot be used directly (without 2/3rds derivative) to DB plans ? (I think so, but I don't want to kabosh someone else's design if I'm just missing something).

[Mike Preston]

Go ahead and kabosh.

[AndyH]

"The next generation" should perhaps be replaced with "the greatest generation" per Tom Brokaw's book about WWII era people. This design sounds more like a WWII era pension plan that one of the Star Trek era.

[Guest jody303]

My recollection (and it's been years, so my recollection may not be that good) is that the "50% rule" also applies to DB plans. (I thought that the limit on the premium for whole life was supposed to be less than 50% of the total cost, though, not exactly 50%.) So, the design you've described may be technically correct as long as the premium is less than 50%.

[Guest Topgun]

Split Funded DB Plans were popular in the 1970's. There is nothing wrong with them.

[JAY21]

I certainly agree there is nothing wrong with a split-funded plan. My concern was more that the numbers shown on this particular proposal seem far in excess of the incidental death benefits using the 2/3rds of ILP funding approach, which I always understood to be the DB algebraic equivalent of the old insurance Rev. Ruling for DC plans stating you could apply up to 50% of the contributions for purchase of whole life insurance. If there is another way of getting substantially more insurance into a DB plan other than the 2/3rds rule or 100 x mo. proj. benefit approach, I would appreciate knowing about it, at least so I don't criticize something legitimate.

[Guest jody303]

JAY21:

Rev. Rul. 74-307 provides that preretirement death benefits will be considered 'incidental' under any type of qualified plan provided that less than 50 percent of the employer contributions are used to purchase such life insurance. I believe the 50% limit was tested under the ILP method, regardless of the funding method actually used by the plan.

As Topgun says, this looks like an old split-funded arrangement. Nothing wrong with it. The 2/3 limit you're talking about would be equivalent to the 25% test for term insurance. The 50% test is used for whole life.