DB plan pays a $1,000 "death benefit" to a beneficiary desig

[Guest beth beaube]

I have a client with a DB plan that pays a $1000 "death benefit" to a beneficiary designated by every participant who dies after reaching normal retirement age. This is intended to be a sort of burial benefit. Is there some advantage to having this contained within the DB plan? Why not provide for this outside of the plan? If there is no good reason to have it in the plan, I would prefer to take it out (assuming that it is not a protected benefit under Section 411(d)(6) since it is an ancillary benefit). Any thoughts would be appreciated. Thanks in advance for your response.

[Guest datalife]

Why remove the benefit. It should be estate tax free (excess of face amount minus the cash value). There are no income implications and the benefit works as an incentive, especially for the low paid beneficiaries, to notify the plan that a participant has died. It creates a small amount of administrative overhead, and the funding through the plan should be cheaper than purchasing similar coverage outside the plan. Finally, it is a benefit that you would be taking away from the participants, at a time when the economy is thriving. I don't know if it is smart business. Good luck with your decision. Mike.

[Guest beth beaube]

Thanks for your response, Mike. If an employer provides a $1,000 death benefit outside of a qualified plan out of its general assets, I assume you are saying this is taxable income to the beneficiary. Are you saying that such a benefit paid through the plan is not taxable income to the beneficiary?

Do we really care if beneficiaries contact us when a participant dies if we are looking at the interests of the company?

It seems to me that the funding outside of the plan would be no different. The company will simply pay these amounts out of its general assets (i.e., it will not purchase an insurance policy of any type).

[Guest Harry O]

Datalife -

What am I missing? Why would this benefit be "estate tax free" and have "no income implications"? It doesn't appear to be funded with life insurance (which would still be subject to estate tax even if life insurance was involved).

[jlf]

If the death benefit is paid from a group life plan, in or outside of the DB Plan, it is income tax free and may or may not be estate tax free depending on the size of the estate. A pre-funded benefit seems to be the better funding method. The premium will be a fixed expense and, therefore, appropriated at the beginning of the fiscal year. A pay-as-you-go benefit is unknowable and may present a funding problem in an off year or two.

Beth: You above all people should know that the death benefit WILL BE PAID sooner or later, with or without a timely notification by the beneficiary. A timely notification is simply helping your client carry out its legal duty. You as the attorney will, therefore, be serving the best interest of your client by encouraging, not discouraging, beneficiary notification. Why would you want to help your client not pay its legal obligation. MOREOVER, HOW COULD THE NON-PAYMENT OF A LEGAL DEBT POSSIBLY BE IN THE BEST INTERESTS OF THE COMPANY YOU REPRESENT AS AN ATTORNEY?

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[This message has been edited by jlf (edited 07-20-99).]

[Guest beth beaube]

Thanks for your comments Larry M and jlf. JLF- I am not suggesting and have never discouraged a client from paying a legal obligation. The only point I intended to make in my previous comment was that, in determining whether to keep this $1,000 death benefit in the plan or to move it outside the plan, the fact that having it in the plan may encourage notification by the beneficiary does not

sway my decision. Don't worry - we plan on paying all of our legal obligations!

Larry M - I am with you. This is only a $1,000 benefit which can easily be paid out of general assets as needed (this is a large company). I too prefer to keep incidental benefits out of the plan to the extent I can.

[Larry M]

whether the death benefit is part of the qualified pesion plan or in a separate plan should be a decision made by the plan sponsor based upon her/his wishes and needs.

Presumably, the 1,000 benefit is a relatively small one which can be funded from general assets and, if the group is large enough, the amount can be budgeted with fairly accurate forecasting. If so desired, the plan sponsor could purchase a 1,000 group term insurance plan for the retirees (perhaps as an add-on to its active employees' group life plan).

My preference is to keep qualified plans as free of incidental benefits as possible and to place those benefits in plans where I can control the flow of money with less restriction and expense.

[david rigby]

I like the idea of encouraging beneficiaries to notify in the event of death. It can be very beneficial to the sponsor because it usually means that you get to stop the monthly payments timely, or change to the spouse, as the case may be. Recovering "excess" monthly payments is a hassle to be avoided if possible.

[Guest beth beaube]

It seems to me that it is irrelevant whether you provide the death benefit in the plan or outside the plan - either way, it provides an incentive for the beneficiary.

[Guest beth beaube]

It seems to me that it is irrelevant whether you provide the death benefit in the plan or outside the plan - either way, it provides an incentive for the beneficiary.

[Guest Dan Ashley]

I believe the tax effects work like this:

1. The $1000 is fully taxable to the recipient if paid out of the pension plan.

2. If the employer buys a group life insurance policy providing the benefit, it is free of federal

income tax to the recipient under Tax Code Section 106.

3. If the employer pays it out of its general assets, the recipient gets hit with federal income tax.

The $5000 death benefit exclusion formerly under Tax Code 101(B) was repealed effective

August 20, 1996.

4. If the employer establishes a VEBA under Tax Code Section 501©(9), there was debate about

whether the benefit was taxable. In a private letter ruling, the IRS has recently opined that in

proper circumstances the death benefit can be free of tax. See LTR 199921036, which was

reported on June 1, 1999 in Tax Notes Today, a publication of Tax Analysts.

If my thoughts are correct, it looks like moving the death benefit out of the defined benefit pension plan may secure a modest tax advantage for the recipients of the death benefit.

-Dan Ashley

Ogletree Deakins Murphy Smith & Polk

[Guest beth beaube]

Dan - thanks for your response. It is very helpful.