Funding for DB plan with life insurance policy

[carrots]

Have there been any "recent" (last 4 years, say!) developments on funding calculations for a DB plan that is partially funded with life insurance?

I had understood that, after PPA, you had to use the envelope method, and would calculate:

1. The TNC, by adding the one-year term cost of insurance to the regularly calculated number,

2. The FT, as normal, and

3. Assets, by adding in the value of the life insurance policy.

I have read that a modified split funding method is possible, but only if the participant's right to receive the insurance benefits is irrevocable (I am not really completely clear on what that means!).

I am running up against some proposals that appear to still be using the old split funding method.

Any comments about how life insurance can still be used to significantly increase deductible contributions?

Thanks!!!

[Guest rex]

You are just paying more for the same defined benefit.

http://www.executivebenefitsgroup.com/images/EBGwp4.pdf

[Effen]

Great response Rex. Much better than "never let legalities get between an insurance salesman and his commissions", which is what I was going to say.

[carrots]

Thanks, Rex and Effen:

Here is an example of competing calculations for a one person plan:

New plan effective: 3/1/2012 (first year 3/1/2012-2/28/2013)

Date of Birth: 3/1/1960 (age 52)

Date of Hire: 1/1/2011

Compensation: $250,000

Plan Benefit: 10% x YOS, LO at age 62

1. Envelope Method:

Maximum AB at 3/1/2012 = ($205,000/12) x (1/10) = $1,708.33 per month.

FT at 3/1/2012 = 1708.33 x 64.5342 (2012 Applicable, 5.54%, 6.85%, 7.52%) = $110,246.

TNC at 3/1/2012 = $0 (Maximum AB at 2/28/2013 also equals $1,708.33).

Cushion Amount = $110,246 / 2 = $55,123.

Maximum Life Insurance = ($205,000/12) x 100 = $1,708,333.

One Year Term Cost of Insurance at age 52 = $1,708,333 x (2.81/1000) = $4,800.

Maximum Deductible Contribution for 3/1/2012-2/28/2013 plan year = $110,246 + $55,123 + $4,800 = $170,169

2. The proposal from the insurance agent has the following numbers:

Compensation $200,000

Projected monthly pension $16,667 at 62

Life Insurance Premiums = $91,369 (insurance amount is $1,556,276)

Investment Contribution = $139,220

Total Contribution = $230,589.

What makes this second proposal legal? Isn't it simply over the limit?

Thanks!

[rcline46]

It is my understanding from the ASPPA conference 2 or 3 years ago that insurance premiums are now irrelevant. You fund the TNC (plus cushion) only. Insurance premiums are paid from assets, and current 'terminal reserve' (cash value) is an asset of the plan, and that is it. No adding in premium for higher contributions. Insurance is not addressed in PPA funding rules. I bet the insurance agent is not an actuary, and no acturary reviewed the calculations.

[Guest rex]

beyond the person paying too much for the same benefit, what happens when the person retires and closes the plan?

you cant roll the insurance into an IRA and thus this person will be likely forced to surrendering the insurance for the cash value (likely a loss especially when you consider inflation) or removing it from the plan at great costs (which they likely wont have on hand).

i bet the client was given a speech just like what i linked and was under the false impression that by contributing more that they will obtain more.

[SoCalActuary]

Rex: the participant could simply start receiving annuity payments from the policy proceeds.

[Guest rex]

Those annuity payments would be based on the cash surrender value.

[SoCalActuary]

Rex, not in the contracts I have read. It would be based on the accumulation value.

[Guest rex]

I believe you are talking about universal life instead of whole life but still the problem is paying the costs for a permanent death benefit but not being able to get what you paid for. You pay more for the same defined benefit and on top of that can't easily get the benefits you paid for.

[carrots]

Rex, SoCal, Effen, rcline and others:

Assume, for the moment, that the employer is not worried about overpaying for life insurance (pretend that the agent is a relative trying to qualify for the Million Dollar Round Table!).

Are you in general agreement with my calculation of a maximum deductible contribution of about $170,169?

Or, do you think that I am way off?

Thanks!

[rcline46]

_{I think you are way off. You need to speak with an actuary based on my earlier discussion. If you look at the schedule SB there is no way to add insurance premium to the annual TNC to get a bigger deduction.}

[Effen]

Another base problem with your calculation is you don't use MAP-21 rates for the maximum. You only use MAP-21 for the minimum. I am also bothered that you say your TNC = 0. Are you saying the plan bases the AB on past service, and therefore the AB that you earn at the moment the documents are signed is attributed to past service and therefore in the FT and not the TNC. I know people use that argument, but I don't understand how you can accrue a benefit that is based on participation, before you actually have any participation, but that is just me. I guess the IRS accepts it, if you recognize past service for benefit accrual.

[AndyH]

I would like to know what happens if owner dies close to NRD in a maximim insurance DB. Would the death benefit equal the insurance plus the pvab, or the insurance with a minimum of pvab. Are the same old tricks being played to justify the death benefit as incidental? And how does the death benefit definition affect the funding in the "proposals". Is the position being taken that there is no pre-retirement mortality assumption, therefore no death and no excess death benefit problem. But what happens if that occurs. Not new questions, I understand; but I wonder what the current thinking is on those items.

[FAPInJax]

The funding of a DB plan with life insurance requires the inclusion of a mortality decrement and the death benefit is valued as such. This produces a much larger required contribution for the death benefit than a term cost (closer to the actual premium). The use of the life insurance is just a funding mechanism that has a poor rate of return (is another way to look it at).

Now, since the employee was hired in 2011, I would have expected a target normal cost for the benefit to be accrued in the upcoming year (in addition to the cushion). I agree with the Effen that the maximum deduction has nothing to do with MAP rates (strictly for minimum).

The death benefit is defined in the plan document and usually is the face amount plus the PVAB minus the current value of the insurance contract (but there are several alternative definitions). This death benefit is valued, in the first paragraph, based on the PPA funding rules requiring a proration based on service.

[carrots]

Thanks, everyone!

Effen - 1.415(b)-1(g)(1)(i)(A) provides for a minimum numerator of 1 in the 415(b)(5)(A) years of participation ratio. In this plan, the benefit accrues over years of service, but is limited to 1/10 of the 415 $ limit at both the beginning and end of the first plan year.

Effen and FAP - Thank you for pointing out that the segment rates for the FT and TNC for 404(o) are not the MAP 21 segment rates! That was a painful miss by me, and explains why my maximum contribution calculations have been coming out too low!

FAP - So, if there is a significant death benefit in the plan, such as 100 x MRB, 1.430(d)-1©(1)(i) says that this must be taken into account in determining the FT and TNC. Since the death benefit is not based on accrued benefits or years of service, it gets allocated per 1.430(d)-1©(1)(ii)(D) - (which is years of service!). If the death benefit is $1,000,000, and a participant has 10 years of past service and 10 years till NRD, would you say that the FT would include the value of a $500,000 death benefit and the TNC would include the value of a $50,000 death benefit? Would you value these as single premium term life, from valuation date to NRD, using applicable mortality and segment rates?

AndyH - I have to think about it!

rcline - The TNC on the SB will implicitly include the value of the death benefit (as will the FT).

[FAPInJax]

You are correct that the funding target would fund for the 1/2 of the face amount (actually the funding of the death benefit which could be different). However, you end up with a much larger charge for the insurance than a term cost.

[Rball4]

New to insurance in DB plans, are premium payments counted as contributions on the SB, meaning that they count towards the minimum required contribution?

[Effen]

yes