Cash Balance Plan Design - 401h and Insurance

[PensionPro]

We are looking at a cash balance proposal by a firm that involves 401(h) accounts and insurance within the plan. I have researched the issues a little but looking for someone to shed additional light. The proposal is for a law firm with five partners and about 45 common law employees. The law firm already sponsors a 401(k) plan with 3% safe harbor nonelective.

Q1. None of the partners are hitting their 415 limit. In which case what is the benefit of the 401(h) account -- is it simply that those contributions are made on a deductible basis by the employer and are not taxable to the participant when distributed to pay retiree medical benefits?

Q2. Under what circumstances is it appropriate to provide life insurance policy within a DB plan and to what extent? What are the pitfalls to avoid -- such as springing cash value, etc.?

We are a little nervous because part of the proposal involves product sales and not merely administration services. I am sure if done right all these pieces work, but I am trying to understand the nuts and bolts to determine if it is in fact appropriate for this client's situation or if the desire to sell product overshadows the needs of the client.

Thank you for the help!!

[Lou S.]

This may sound cynical and I'm sure there are many valid reasons to have insurance in a DB plan beyond generating commisions for the broker, but I haven't really seen them in practice.

[david rigby]

Q1. I think your synopsis is correct. However, some Key EE issues to worry about?

Q2. The most common reason for life insurance in a DB plan is to provide a boat for the salesperson. Second most common might be to provide whole life, since you cannot buy it with deductible contributions (I think) outside the plan (I'm not saying it's a good idea). If the 415 limit is not in play, it might make sense to put those dollars toward increasing the retirement benefit (DB or DC) rather than Life Ins.

Many years ago, a wise consultant told me to think of "hazards": the hazard of becoming disabled, the hazard of dying, the hazard of reaching retirement without enough money, the hazard of having large medical expenses, etc. and to keep those hazards separate when spending your compensation dollars. The result is you buy term life insurance, or disability insurance, rather than provide those benefits inside a DB plan. ERISA created a requirement to have a spousal death benefit in a DB plan, but many plans (most?) don't provide anything more generous, usually because term life is an inexpensive method of doing so.

[PensionPro]

Thank you for the helpful responses!

[figure 8]

Just wanted to revisit the 401(h) part of this question that was originally posed years ago:

"None of the partners are hitting their 415 limit. In which case what is the benefit of the 401(h) account -- is it simply that those contributions are made on a deductible basis by the employer and are not taxable to the participant when distributed to pay retiree medical benefits?"

Since there wasn't a lot of talk about this, I just wanted to revisit: if someone wants to utilize a 401(h) account for healthcare costs, and they plan to have a solo DB plan as well - is there any reason to steer them away from the 401(h) part? Anything to watch out for? I just haven't dealt with this scenario before. Thanks for any advice. 

[shERPA]

I'd love to be able to do 401(h).  We did it BITD before the '84 act made the contributions an annual addition.  Yes, if used to pay retiree medical, it is a tax-free distribution.  But there are problems:

1.  Can't terminate the plan.  Or if they do the 401(h) assets revert.  There is someone out there circulating marketing info that says otherwise, but IRS guidance is very clear.   Could probably terminate the DB and transfer to a frozen MP to continue the med account, this would simplify a bit, but still have to have a plan sponsor until the med account is spent.

2.  No VS plan documents that I'm aware of support this.  And doing individual plans now is difficult WRT ongoing determination letters.

3.  Like any ancillary benefit it has to be non-discriminatory.

Life insurance in the plan?  Not a fan.  If it is a law firm it should be a combo plan.  If it is a combo plan then the NHCEs are likely getting close to the (a)(26) minimum 1/2% benefit.  If ancillary death benefits are added at the 100x factor, the HCEs get discriminatory death benefits.  Adding life insurance in the DC is not a solution because the premium expense reduces the ultimate DC retirement benefit whereas in a DB the retirement benefit is not reduced.  IOW in a DC the life insurance is ER paid, in the DB it is ER paid.   Someone is offering this with an extra ER DC contribution to NHCEs to pay for the insurance.  Might work, but lots of brain damage.  And lots of expense to the employer that never get to the ees due to ee turnover and policy surrender charges.  Also must annually report cost of insurance as income to participants (Ins cos and agents love to hang this on TPAs).  

I am sure if done right all these pieces work, but I am trying to understand the nuts and bolts to determine if it is in fact appropriate for this client's situation or if the desire to sell product overshadows the needs of the client.

Ya think?