Life Insurance in DB plan

[ac]

We have a client that has been purchasing life insurance in it's DB plan. The client has been purchasing up to a face amount of 100 times the projected accrued benefit.

The client has decided that the principal has enough life insurance and wants to stop purchasing. What are the clients options? Obvisously the plan must be amended to eliminate the use of life insurance, but what can be done with the life insurance in the plan now? Any suggestions?

[Ron Snyder]

Options available include: (1) Cancel (cash in?) insurance policy; (2) Turn the policy into "key participant" insurance as a plan investment.

Plan documents need to reflect decisions made.

[Kirk Maldonado]

A third alternative would be to "rollout" the policy to the participant. There is a DOL Prohibited Transaction Class Exemption for those transactions. However, you need to see if you can meet all of the conditions for that exemption. (I honestly don't know if it works in the case of a defined benefit plan; I've never had that come up before.)

[GBurns]

Is so much life insurance allowed in a plan?

Who owned the policies?

Who are the beneficiaries?

What was the purpose of purchasing so much life insurance?

I think that all these have to be taken into consideration in order to make a decision.

[Belgarath]

Lat's see...

With the obvious caveat that the terms of the document must be taken into account, some general thoughts. Both Vebauru and Kirk have put forth some ideas. Kirk - yes, this can be done in a DB plan. Vebaguru - while I don't disagree that using it as "key person" insurance is possible, I must say I'm not a fan of the concept. It seems that in many cases, justifying it could be difficult. Not saying it is impossible, just perhaps questionable in many circumstances. Personally, I'd go with Kirk's suggestion, or surrender as you mention.

GBurns - yes, this much insurance is perfectly allowable in a DB plan. Either the "100 times" limit or the RR 74-307 "2/3 rule" have both been approved as "incidental" by the IRS. The pension trust owns the policy. The pension trust is also the beneficiary of the policy. (proceeds paid to the trust, then distributed to the participant's beneficiary as provided under the terms of the death benefit payable under the trust.) Purpose for purchasing? Obviously unknown from this end, but presumably to provide a benefit if the participant dies prior to accruing a full benefit. In a DB plan, this is a very nice benefit for the participants, as it doesn't have any negative effect upon their ultimate benefit. Might not be quite so attractive for the sponsor who has to pay for it, but I'm assuming they wouldn't buy it in the first place if this were a problem. I typically see this only in very small plans where all or most of the benefit goes to the owners and family.

[ac]

Thanks for the replies.

Is it possible to freeze the insurance level at the 2003 level? In other words, the 2003 projected benefit is $10,000 per month for the key employee, so the plan has purchased insurance policies with a total face amount of $1,000,000 at the end of 2003. At the end of 2004, the projected benefit is $11,000. Is it possible from a non-discrimination standpoint and does it make sense to freeze the level of insurance and the death benefit at the $1,000,000 level? There are a few non-highly compensated employees in the plan.

If it is possible, the plan can still provide a substantial death benefit and not pay the surrender charges.

Any thoughts?

I have very limited experience with life insurance in DB plans so any suggestions would be helpfull.

[david rigby]

It is my understanding that a plan or an amendment can discriminate against HCEs (or even among them), so establishing a maximum life insurance level (more properly, is that establishing a maximum death benefit?) should be permitted.

[AndyH]

ac, many (most?) practitioners say it makes sense to REMOVE the insurance from the plan, which I happen to agree with, so freezing or reducing it is a step in the right direction.

The only problem that I see with freezing the level is that new participants would not have that benefit, and that would be a testing issue under benefits rights and features, and eventually you might have a problem. I would instead scale back the insurance to a uniform multiple of the benefit (if not remove it).

[Belgarath]

Andy - I think what he means by "freezing" the death benefit is really "capping" the death benefit level. So new participants would have life insurance purchased, up to the cap level, but not beyond. If that's the case, no discrimination there, as Pax mentioned.

[mwyatt]

My reading was that he wasn't talking about a max cap, but not increasing/adding policies beyond the total face held in 2003, so Andy's point was on target. Clarification by "freeze" please?