412i Coverage

[Guest merlin]

I have a 412i plan that was installed at the end of 2004. The plan document defines the accrued benefit as the value of the contracts. Insurance policy and annuity cash values are -0- at 12/31/04. Can I take this literally and say that nobody benefits for 04? Seems like a cheap way out of coverage and top heavy.

[Guest Roman]

Heard from Jim Holland in a recent ASPPA meeting that if a 412i plan has an accrued benefit equal to the cash value, then it is not a safe harbor plan. If it is not a safe harbor plan, then you have to do a general test for non-discrimination.

[Guest merlin]

That's cruel. I thought that defining AB=Cv was part of the safe harbor for fully insured plans? But if the CV=0, what's to test? I hope he's not trying to apply the FMV rulesto this.

[Guest Roman]

I guess the issue here is can the cost of insurance be part of the benefit. If so, even if the cash value is zero, if the plan pays for the cost of the death benefit, then the participant benefits. Any comments?

[Guest DFerrare]

See 1.410(b)-3(a)(2)(iv). Generally, an employee in a 412(i) plan is benefiting for a plan year if and only if a premium is paid for the employee for the year.

[Guest merlin]

OK, They're benefiting. To what extent? The plan only references the cash value, with no mention of the cost of insurance. Where does that leave me?

[Guest Roman]

The answer to your question of are they benefitting is yes. To do the general test, I say you use the cash values.

[AndyH]

That'd be one funny looking general test, all zeros but everybody benefits. Not a lot to do there. I'd call it a day there Merlin.

Thank the agent; he got the first year cash values.

[Guest Roman]

The fun begins when the cash values start appearing. Enough time for the agent to start running.

[Belgarath]

I'd be interested in Mr. Holland's arguments for this, if that's really exactly what he said. I'd refer him to 1.401(a)(4)-3(b)(5).

[Guest merlin]

Amen to all of the above. Thank you all for your input.

[Guest Roman]

A 412i plan whose definition of accrued benefit is the cash value does not satisfy 411(b)(1)(F), according to Jim Holland. Now if you change the accrued benefit to the fractional accrual, then it becomes safe harbor. But in doing so, you need the services of an actuary.

[Guest flogger]

It seems to me that Rev Proc 2004-16 requires that cash value MUST be at least as great as the aggregate of (1) premiums paid through date of determination plus (2) Interest dividents etc, minus Reasonable mortality and other charges. Do "other charges" include reductions due to commissions/overrides?

It seems to me that the fair market value of a policy should be considered for accrued benefit measurement--as that is the benefit that must be reported in the event of a distribution of the policy. If CV per the policy in your case ($0) is determined after surrender charges, then that would not be FMV. Any other thoughts on this out there?

[Guest merlin]

I thought the FMV issue only arose with regard to valuation of a policy for purchase, or for taxation on distribution.

[AndyH]

Both good comments and both sound right.

Merlin, just for fun, did the entire contribution become worth $0?, so that somebody took a deduction which disappeared? When does the CSV equal the premiums paid?

[Guest flogger]

This is untested ground for 412i's I believe. It is also another opportunity for the insurance industry to abuse. If the insurance industry continues to abuse 412i's like it did 419's (and the list goes on), then certainly we'll get more promulgations that will tightened the noose on 412i's--and then the insurance industry can move on to the next abuse.

Certainly some insurance carrier can come up with a product that has reasonable CVs at all ages that can also provide a retirement benefit. CVs in a 412i (in my opinion) should be fairly close to what PVABs would be in a traditional plan. I don't know of any rules/regs that stipulate min levels of CV as they relate to benefits. The way that such a policy can be priced is to make insurance commissions reasonable so as to allow the policy to accumulate some strength. But who would sell it?

[Belgarath]

Mr. Holland may well not like 412(i) plans. I don't like them either, although I don't raise my dislike to the vitriolic level that many folks do. Nevertheless, there's a big difference between not liking them, and inventing a reason why they can't be a safe harbor by unofficially contradicting established statutory or regulatory authority. Can someone explain to me how Mr. Holland derives his theory, based upon the following?

411(b)(1)(F) CERTAIN INSURED DEFINED BENEFIT PLANS. --Notwithstanding subparagraphs (A), (B), and ©, a defined benefit plan satisfies the requirements of this paragraph if such plan --

411(b)(1)(F)(i) is funded exclusively by the purchase of insurance contracts, and

411(b)(1)(F)(ii) satisfies the requirements of paragraphs (2) and (3) of section 412(i) (relating to certain insurance contract plans),

but only if an employee's accrued benefit as of any applicable date is not less than the cash surrender value his insurance contracts would have on such applicable date if the requirements of paragraphs (4), (5), and (6) of section 412(i) were satisfied.

412(i) CERTAIN INSURANCE CONTRACT PLANS. --

A plan is described in this subsection if --

412(i)(1) the plan is funded exclusively by the purchase of individual insurance contracts,

412(i)(2) such contracts provide for level annual premium payments to be paid extending not later than the retirement age for each individual participating in the plan, and commencing with the date the individual became a participant in the plan (or, in the case of an increase in benefits, commencing at the time such increase becomes effective),

412(i)(3) benefits provided by the plan are equal to the benefits provided under each contract at normal retirement age under the plan and are guaranteed by an insurance carrier (licensed under the laws of a State to do business with the plan) to the extent premiums have been paid,

412(i)(4) premiums payable for the plan year, and all prior plan years, under such contracts have been paid before lapse or there is reinstatement of the policy,

412(i)(5) no rights under such contracts have been subject to a security interest at any time during the plan year, and

412(i)(6) no policy loans are outstanding at any time during the plan year.

Now, I frankly see no way that there could be a cash surrender value of zero. I've never seen, nor heard of an annuity that has a zero CSV if the required premium is paid - hard to believe a state banking and insurance department would approve such a policy. But even if they did, I respectfully submit that Mr. Holland is dead wrong. If the IRS wants to rewrite the regulations, that's fine, but his comments from the podium on this issue (again, if that's what he said - I wasn't there!) are off-base.

[Guest flogger]

Don't forget that if you have insurance and annuities used to fund a 412i, that they must be part of the same series of policies. I know of only one company that provides a product "series" that contains both annuity features and insurance feature so that this technicallity can be met.

Belgarath is right about the IRS constantly legislating beyond their bounds.

[Guest merlin]

With regard to the questions about cv=o, I think it's partially due to the fact the policies weren't issued until very near the end of the year. But it's also my understanding that most 412i policies have very heavy expense charges in the early years of the policies, so that it takes several (5-7?) years before there is significant cash value accumulated. Wasn't that the primary rationale behind the FMV rule?

As for the requirement that the insurance policies and the annuities must be of the same series, doesn't that dissolve into a BRF issue? I think I've also heard Holland say that since anuuities and insurance policies are inherently different they can't possibly meet the "same series" requirement.

I've been able to avoid handling 412i plans up to now. Everything has been hypothetical. This one is my first real exposure. There's a lot of OJT going on.

[Guest FLMaster]

Impossible, there has to be cash value in the annuity. There are no annuities that qualify for 412(i) when filed in the respective states that would allow this to happen. Hope this is helpful.

[ak2ary]

Flogger -

Holland has said, in writing, that life contracts and annuities are inherently of different series. Thus all 412i's with both insurance and annuities are non-safe-harbor 412i's subject to the general test. Since no one has any clue as to how to run a 412i general test (for instance is the lapse of a surrender charge a benefit accrual?), you have real problems with any 412i's that are not annuity only. and since those annuity only 412i's don't commission all nice like the life insurance 412i's ya don't see many

[Guest FLMaster]

You may have a listed transaction if there is no cash value in the plan.