Disability Benefit

[JAY21]

I believe a Qualified Disability Benefit can be an unreduced annuity benefit payable at the disability age (say 40) that that would have otherwise been paid at NRA including the future service/participation through NRA. Does anyone have any thoughts or opinions as to whether the present value of such unreduced Disability Benefit (annuity) can be paid out as a lump sum ? If the lump sum exceeds the present value of the current 415 limit, is that an issue ? I'm leaning towards thinking the Qualified Disability Benefit could be paid as a lump sum, even if greater than current age 415 limit, given it's an ancillary benefit not an accrued benefit subject to 415 limits (much like life insurance that complies with the incidental death benefits limits may be greater than the current 415 limit). However, I don't find much discussion or passages in our various reference sources on this topic so I would appreciate any thoughts or opinions on this.

[Effen]

I have never heard of a disability benefit that is payable as a lump sum. What would you do if he recovered, ask for the money back?

I have no idea about your question. My only exposure is was with a plan termination. In that case the participant was offered an annuity (the annuity he was receiving) or the lump sum value of his acc ben commencing at NRD.

The disability benefit is completely ancillary and can be taken away. I would think if it was not subject to 415 you would find a lot of "disabled" doctors.

[mwyatt]

The give and take of a disability benefit is overcompensating with the annuity stream due to the probability of shortened mortality. Are you proposing paying a lump sum on an unadjusted accrued benefit for early commencement due to disability, using normal mortality tables?

[JAY21]

Yes, presumably it would be the unadjusted benefit using normal mortality tables. It's a one man plan (no employees) and there's an ERISA attorney involved so I've just been requested to give my input. In the past I have seen some plan docs where the disability is a flat amount (e.g. $100,000) for say losing a limb and maybe something different for eyesight. It always struck me a little morbid to put a value on each part of the body but these were plans with determination letters drafted by a different ERISA attorney. I can't find anything that states the benefit can't be paid as a lump sum equal to the present value of unadjusted benefits (even if it exceeds the 415 limit), but Effen's comment about a potential recovery is a good point, though in a one man plan I guess there would be no one to ask for a refund upon recovery and presumably the plan would subsequently terminate. I do believe a lump sum settlement (conversion) of disability benefits in pay status is sometimes offered by insurance companies to certain disabled beneficiaries outside of qualified plans, presumably on those with rather permanent disabilities. Perhaps it comes down to how permanent the disability is, to justify a lump sum if no recovery can be reasonably expected, and whether the type of disabiliy is such that a special disability mortality table should be used.

[Effen]

I assume the assets exceed the max 415 lump sum, otherwise you could just terminate it.

I think it could be difficult to explain to the IRS why you paid a benefit to a disabled participant that exceeded the maximum benefit payable to a heathly participant.

[JAY21]

Yes, I agree that large of a lump sum (more than 415 limit) doesn't look good. However, if the owner participant's accrued benefit is projected to be capped by the 415 limit at NRA then of course the Qualified Disability Benefit payable unreduced at a younger age is more valuable as an annuity. The lump sum just reflects that on a present value basis (assuming a healthy mortality table can still used). Let me be clear I'm not trying to champion the approach, just trying to probe its soft spots so I can give some feedback.

[Larry M]

Jay21,

I agree with your analysis.

If the plan provides a benefit, in an annual (or monthly) amount equal to the individual's normal retirement benefit, and payable when the individual becomes disabled (as defined by the plan - not necessarily the social security definition), it is an "incidental" benefit and does not have to be reduced for payment commencing prior to NRA.

Therefore, you can provide a benefit of 175,000 per year payable when the individual becomes disabled - even if it is at age 35.

The benefit can be payable as a lump sum at, in this case, age 35.

It is a taxable benefit to the individual.

[mwyatt]

Seems a tad aggressive to me, given the one-man, 415 limit, circumstances. Paying the unreduced benefit as an annuity stream I could see. A little bit of a stretch on the lump sum amount (otherwise we would counsel our overfunded plan sponsors to have a nervous breakdown). I'd do a little more research than posting here before proceeding.

[Effen]

CCH-EXP, PENSION-PLAN-GUIDE ¶1565, Unrelated Benefits Do Not Count

Unrelated Benefits Do Not Count

For purposes of the actuarial adjustment required when a plan pays a benefit in a form other than a straight life annuity (see ¶1561), the value of benefits that are not directly related to retirement benefits are not taken into account (.05 ). For example, no adjustment is required for the value of such ancillary benefits as pre-retirement disability and death benefits and post-retirement medical benefits. Thus, pre-retirement disability benefits are not directly subject to the limits imposed by Code Sec. 415 (.07 ).

However, because a qualified disability benefit may not, under Code Sec. 411(a)(9), exceed a participant's normal retirement benefit (see ¶2565), a qualified disability benefit may not exceed the benefit that would be allowed under Code Sec. 415 in the event that the participant separated from service at normal retirement age. In addition, disability benefits provided under a defined benefit plan that exceeded the early retirement benefit and the benefit provided on separation from service at normal retirement age are not ancillary benefits that could be disregarded in applying the Code Sec. 415 benefit limits (.10 ).

Cost-of-living adjustments. A plan may provide for benefits that reflect post-retirement cost-of-living increases. This feature is not taken into account to the extent that the benefits comply with the limits, as adjusted for cost-of-living increases (.15 ).

.05 IRS Reg. §1.415-3©(2)(ii).

.07 IRS Letter Ruling 9852044, 9-29-98, at ¶17,401K.

.10 IRS Letter Ruling 9237042, 6-18-92.

.15 IRS Reg. §1.415-3©(2)(iii).