Split Dollar vs. Associated Salary Continuation Plan & 409A

[namealreadyinuse]

Based on the preamble, most split dollar (at least death benefit) is not subject to 409A, but I have heard people use it to justify ignoring 409A for the overall salary continuation agreements that are funded by split dollar.

They are really separate concepts, right? The split dollar is really a type of funding mechanism (not funded for ERISA of course) with its own tax features that has to be run through the 409A gauntlet. I also think any salary continuation agreement or other deferred compensation agreement that may be associated with the split dollar is separate and has to be analyzed independently? Is that right?

In light of this, is it smart to just try and get what you need from a split dollar policy without a stand alone salary continuation agreement to avoid 409A?

[Ron Snyder]

Perhaps IRS will clarify whether they really are separate concepts. IMHO the language of 409A refers to split dollar arrangements, not just to the policies. For any split dollar arrangement there is now a choice: consider the policies to a funding vehicle for a "salary continuation agreement", or draft a "split dollar agreement" that clarifies the terms of the split dollar plan and incorporates the policies as a part of the plan. If someone doesn't wish to be subject to 409A, the latter approach should be sufficient.

Query: What if an arrangement is part of a split dollar arrangement but violates one of the requirements of the split-dollar Regs? Does that make 409A suddenly applicable as of the failure date? I think so. Other thoughts?

[Locust]

How can you fund a salary continuation agreement with split dollar insurance? [split dollar means (to me) that the employee will get the death benefit and will have some rights to the equity in the policy. Is it possible that the idea is that life insurance on key persons (perhaps the one with the salary continuation agreement) is owned by the company and the inside buildup will provide the assets to pay the benefit, that's not my concept of split dollar.]

Are there insurance guys out there who think (wishfully) that split dollar is still a way to provide deferred compensation?

[Guest mjb]

Name: I dont understand how the preamble permits ignoring 409A for salary continuaton funded by SD since the preamble states that SD are exempt from 409A if the only benefit payable is a death benefit or the arrangment is structured as a loan where there is no binding promise to forgive the dept or charge below market interest rates. Pre 9/17/03 arrangements are exempt from 409A if there is no material modification after that date. The SD arrangment is exempt from 409A if the only benefit under the arrangement is a death benefit to the bene of the covered employee. If the cash value of the SD policy is available to pay continuation benefits under the arrangment then the SD policy/salary continuation agreement would be subject to 409A. The preamble notes that the application of 409A to SD arrangements not exempted will be addressed in future regs.

[namealreadyinuse]

I definitely shouldn't have typed "most" because I am sure that the 409A execption for split dollar is narrow in practice.

It sounds like any NQDC contract will have to meet 409A or its exceptions independently of any underlying policies.

[Ron Snyder]

Locust: Split dollar refers to shared-ownership arrangements. An employer may purchase a life insurance policy on an executive and assign the ownership of the cash value to the employee. Of course the executive will be taxed on the non-protection premium paid each year, so that part of the benefit is not "deferred". Some employers even bonus enough extra for the executive to pay the taxes on such premium amount.

The balance of the increase in the value of the insurance policy due to increases in the underlying investment value of the policy is available to the executive tax-free via policy loan after retirement.

While this is not what most of us think of as deferred compensation, it contains some elements of DC. Such arrangement was excluded from 409A.

[Guest mjb]

I think arrangement that you describe is the one that will be subject to 409A for which the IRS reserved the right to issue regs under 409A. I dont think the employee will be able to remove CV of the inside buildup of SD polices owned by the er as a loan to avoid taxation under 409A.

[Locust]

Vebaguy - What you describe is not what I would call split dollar, but the purchase of life insurance by the employee that is facilitated by the company. Isn't that what's happening? Someone tried to explain to me why this was a benefit, and the answer was that life insurance for executives through a corporation is cheaper to buy than regular insurance because executives are richer and have health insurance. I'm not sure I buy this but I'm not an insurance guy. Warning - I've seen enough blown insurance deals to be highly skeptical.

[Mark Whitelaw]

As an executive benefits "insurance guy" I'll try and provide an overview of some of the items. Warning - I have a tendancy to be chatty.

The 9/17/2003 regs. eliminated equity split types of split dollar and replaced it with a loan regime – individual owns the policy, the employer is lending the individual money to fund the policy, the individual owes the company principal and interest, minimum interest tax rules apply. A financed approach to buying personally owned life insurance with the employer as the bank.

The regs retained the economic benefit approach, what was referred to as endorsement split dollar – the company owns the policy and shares part of the death benefit with the individual, the individual is charged an imputed income for the economic value of the amount of personal death benefit protection. A common and cost effective way for a company to provide extra death benefit protection.

There was a plr years ago that clarified if the company is using COLI to informally fund a deferred comp plan and was separately sharing part of the death benefit to provide a supplemental death benefit (using the policy for double duty), that was ok. The 409A preamble reconfirmed that scenario.

And while there are two basic methods, I’d expect there are creative uses of the loan regime to create a value as an alternative to an employer funded SERP under 409A. I agree with Locust – too many blown insurance programs and be skeptical – at least do a thorough downside risk analysis. I haven’t heard of loan regime being used as an alternative to elective deferral, but I’m sure it’s out there somewhere. I’ve never found much value in the equity split or loan versions of split dollar. Endorsement is a good way to provide some cheap supplemental death benefit protection.

As an alternative to an elective deferral under 409A, the recent ability of a qualifying employee to personally purchase institutional life insurance (ILI) on an after-tax basis is for most more valuable than deferring pre-tax under 409A. While 409A is used as a supplement to 401(k), personally owned ILI can be used as a supplement to those capped in a Roth 401(k). Like Locust had been informed, the lower risk rates on executives in the institutional risk pool generates values much superior to retail products and greater than taxable or tax deferred savings programs - the cost of insurance is less than the cost of taxes.

No tax games, no stretching legal interpretations, simply personally owned life insurance designed for maximum immediate and long term cash accumulation, maximum level of efficiency due to a low-load institutional pricing and the lower risk rates of upper income white-collar employees. Cash surrender value starts at 100% of contribution, insurance costs that are less than taxes on savings alternatives, and supplemental insurance protection for one’s family. A value only available in the workplace to qualifying employees (QE) – Top 35% by compensation in white-collar roles - Ages 20-70. Not so much an insurance program in the classic sense, but today upper income employees are living so long and the resultant guaranteed issue rates so cheap that one can build more cash for life’s needs inside ILI than elsewhere plus have some extra cash for our family when we die. A great personal value and the employer's role is merely a facilitator to a personally owned lifelong value - simply validates employment. Everything else is coordinated directly with the QE.

Hope this helps - Mark

[Locust]

Mark - Thanks. A very lucid explanation.

[GBurns]

Mark

What is "institutional life insurance" ?

Who sells it ?

[Mark Whitelaw]

ILI in its corporate owned form is COLI, in its bank owned form is BOLI - you can count on one hand the insurers that are the real players in the marketplace - New York Life is #1.

Any approved CBA (corporate benefits administrator) has access. It's simply their option now to sell it as either employer owned or employee owned. Most still sell it as employer owned to informally fund a 409A plan. But today the greater value from the employee's perspective is to personally own the asset, not be the recipient of a promise to pay. The employer also doesn't have the hassles and expenses of everything involved in backing that promise. That move also transfers all the responsibilities and service infrastructure from the employer to the CBA - a transfer many don't want to take on, especially as most employers are unwilling to pay an admin fee for a personally-owned asset. Plus - 409A gave CBA’s plenty of work and new opportunities for years to come. We re-engineered our 20+ year practice in 2002 from employer provided executive benefits to employer facilitated key employee benefits. Our niche.

[Ron Snyder]

The ILI Mark refers to is frequently provided through policies not available to the general public through normal agent channels. The contracts must have good investment value (high minimum face, low mortality charges) to be successful. Companies like John Hancock, Mass Mutual, Pac Life and MetLife are also quite active in the market.

[Mark Whitelaw]

Exactly right. But in this case the objective is to minimize the death benefit to minimize the lower insurance costs - riding the 7-pay limit for the first seven years. This is about cash, not death benefit. And all the carriers you mention have comparable products. The employer's selection of whos product to offer is not about value - they're all good products, it comes down to ratings, reputation and underwriting. It then is the employer's choice of who they want to offer. Take care - Mark

[GBurns]

I do not understand what you mean by "not available to the general public". I thought that insurance products were available to anyone who qualified.

I also do not understand "though normal agent channels". I thought products were available only through agents. However, I am aware that there are some products that are used in the Advanced Market and other specialized areas, that some "regular" agents might not service. But that does not mean that the product is not available to every licensed agent. I am also aware that there are some "proprietary" products which are restricted to "special" agents. Are you saying that these particular insurance policies are restricted to certain agents or agencies?

I also was not aware that anyone other than licensed insurance agents could sell insurance products. A lawyer who has an insurance license and who sells an insurance policy does so as a licensed insurance agent not as a lawyer. So a CBA, whatever that is, would also be selling the insurance policy as an insurannce agent not as a CBA. Which, to me, means that it is the insurance agent who has access to these products not the CBA.

COLI and BOLI are not insurance products or policies. They are just the designation used to describe the ownership of the insurance policies. The underlying insurance policies could be Whole Life, Universal Life or Term Life in any of their various forms. In other words you cannot buy a COLI policy but a Corporaton/Company/Bank can buy an insurance policy and if it retains the ownership the insurance policy is regarded as Corporate/company/Bank Owned Life Insurance (COLI/BOLI).

I cannot see what ILI has to do with COLI or BOLI. I have never before seen or heard of Institutional Life Insurance and a Google search did not bring up much. Is it that "Institutional" does not refer the product but to the target market.

I know of Private Placement Life Insurance and other "Investment" life insurance products that have the characteristics that you describe. I also know of certain very high cash value/low death benefit policies that can be structured to do almost as well. None of these are referred to as Institutional Life Insurance. But all can and are sold to institutions.

[Mark Whitelaw]

Only agents can sell insurance.

A small number of insurance companies have special units that design products specifically for the institutional (corporate and bank) marketplace.

COLI and BOLI has a dual meaning – it describes ownership as you described, but it also describes the marketplace the institutional life insurance products are designed. Hence, the institutional divisions refer to their COLI and BOLI products. And some have private placement hybrids for these markets.

Some institutionally priced products are not available for individuals to own. They are filed specifically for ownership by a business. Others for owners or employees.

Institutional product providers restrict access to agents with corporate benefits, NQDC administration experience/capabilities. Some refer to these approved agents as Corporate Benefits Administrators – CBA’s. Carrier based administration like you see in retail insurance is typically not available, policyowners don’t call the carrier – the policies are not on the carriers retail administration system - service is coordinated through the CBA. Another part of the pricing concession.

Institutional products available for employee ownership are only available through an employer. The employer co-signs the application certifying that the employee is part of the top 35% and performs a white-collar role. Groups of 15 or more qualifying employees with $100,000 or more combined premium get guaranteed issues. A single employee can medically qualify and the minimum initial premium is $200,000. Guaranteed issue rates are cheaper than the medically qualified coverage.

Any cash value policy can be managed for cash – institutionally priced products simply does it best. Most at guaranteed issue rates build greater cash than retail products medically underwritten at select preferred. Assuming a positive rate of return, most cash surrender values exceed 100% of premium from day 1. At a 9% gross rate of return, year 1 cash surrender values of 106%-107% of premium are typical. There are mass marketed business life insurance products that get you to 80% or 90%, but they don’t provide comparable value or have the underwriting.

Hope this helps.

[GBurns]

Can you name a few products that are actually called "Institutional Life Insurance"?

Can you name a few of these that have been "filed specifically for ownership by a business. Others for owners or employees." ? What states allow this?

Can you name a few companies that use the term "Corporate Benefits Administrator" to describe the agents?

I am not saying that these things do not exist as you state, it is just that I have never heard of these and I cannot find anything that explains or coroborates what you state.

[Mark Whitelaw]

Institutional Life Insurance is a generic term - it helps clarify that you are talking about a different breed of product. ie. New York Life Advanced Markets Network has their regular VUL products and uses the term Investment-oriented Institutionally Priced Life Insurance to describe their Corporate Executive VUL IV product in their SLIRP brochure (Supplemental Life Insurance for Retirement Planning). Talking in terms of an institutional design helps in conversations when discussing these products compared to all the _OLI variations (COLI, BOLI, POLI, FOLI, SOLI, ChOLI, etc.) ILI is a generic term I've used for 10+ years to distinguish a product design, not it’s usage.

Couldn't tell ya specifically which products today are filed in which manner. Not my area. But when approaching some of the carriers five year ago about using their “COLI” product in an employee owned manner, and not CA split dollar, I was told by many that their product wasn't "filed" for individual ownership. I hadn't heard of that before also. I was told I’d have to wait for their next version, they would “dual file” it for both business and individual purposes. You also have the issue that some insurer’s administrative systems for these niche products are designed around corporate ownership - multiple policies all with one owner, one beneficiary, a common asset allocation, death benefit option, etc. That’s less of an issue today than it was four years ago.

CBA, or Corporate Specialty Broker (CSB), Corporate Specialty Agent (CSA), etc. Each company has its generic term to describe individuals approved to distribute their multi-life market products. For years I was a CBA because I ran a fee based TPA of nonqualified benefits. Today I only administer what I sell, so I guess I’m now a CSB. Never gave it any thought until today. Doesn’t matter the expression a company uses, the key for our discussion is depending upon the carrier, an agent has to go through an added level of due diligence by the carrier to be approved to distribute these products.

This is a niche area, and as vebaguru pointed out, great handle incidentally, one that only a few insurance companies deal in. And like so much in the insurance business, is filled with niche expressions. It’s like the topic of Split Dollar – the source of this thread. Prior to 2003 we had calculated over 680 ways a split dollar agreement could be structured. Ya gotta love the creativity of the insurance industry.

[Ron Snyder]

You said that you were not a man of few words. However, I couldn't have said it better myself. 680? It's amazing you kept your posts so short.