415 Limit Solutions

[jim241]

There's a cash balance plan with the annual benefit going to the owners (HCE's) in the plan that is above their 415 limits. If their benefit is limited, the thought  is to have the plan buy each of them an annuity with a X% surrender charge.  This would make the taxable distribution effectively identical to the 415 limit.  The annuity would be transferred to them for conversion to an IRA after IRS approval was received.  We would offer this identical distribution to the other participants.

Any thoughts on this? 

[Mike Preston]

I don't think you want them.

[jim241]

Would you mind elaborating Mike?

[david rigby]

Let me guess, there is an insurance agent involved?

[jim241]

Yes, but it's more of an attempt to avoid 415 issues, penalties, excise taxes etc. 

[Lou S.]

Are you trying to pay the insurance company salesman instead of the IRS?

Is the policy set up as a "springing cash value" policy? If so I think those are frowned upon by the IRS.

I don't think the mere fact that contract has an early surrender change allows you to value the policy assuming it is immediately surrendered. I'm pretty sure you need a fair market valuation of the contract.

 

[Mike Preston]

No.

[ERISAAPPLE]

Are you saying you can exceed the 415 limit by the amount of the surrender charge?  If so, I don't think that works.

Are you saying you can put in the 415 limit, have the plan buy an annuity with that funding in the same year, and then fill up the bucket again in the same year over the 415 limit?  If so, I'm not sure that works either.  

If you are saying fund the plan up to the 415 limit and then use the excess outside of the plan to buy an annuity, I don't see a problem with that.  

[jim241]

I think the intent is to have the plan purchase an annuity in order to "eat" some of the assets to get below the 415 limits. 

[david rigby]

Good grief!  Paying an admin fee just to get below a threshold? 

Somebody needs some advice from a pension actuary well-versed in small plans. 

[Luke Bailey]

The annuity has to be valued for 415 purposes.  If, as seems likely, the sales charge is contingent and/or variable, the actuarially likely charge (not the maximum possible) would need to be used to value the annuity.

[ERISAAPPLE]

On ‎3‎/‎16‎/‎2018 at 11:56 AM, jim241 said:

I think the intent is to have the plan purchase an annuity in order to "eat" some of the assets to get below the 415 limits. 

Why would the expense of the annuity paid by the plan not be considered a 415 annual addition?  The money that is used to pay for the expense must have been contributed to the plan.  

[SoCalActuary]

Generally, I have encountered this argument as one in which the lifetime maximum benefit is funded by a product with an under-performing investment and a level of sales and administrative expense. 

The alternative is to pay the maximum lump sum, roll to an investment account, and then earn market rates of return, resulting in more money in the beneficiary's hands.  The surplus funds remain in the pension plan unless there is no remaining plan sponsor, until the funds can be used to fund someone else's retirement, like a relative, or a successor to the business, or a replacement plan.  If no other choice, then pay the excise tax.

[Mike Preston]

SoCal.... people are missing the point of the OP.  The methodology described is a variant on the springing cash value gambit.  Invent a policy with a surrender charge.  Pretend that the amount being treated as a taxable distribution is the amount that would be distributed from the annuity immediately after purchase where the surrender charge is in full force and effect. Provide for the elimination of the surrender charge over time along with the ability to convert to a lump sum at some time in the future when the surrender charge will be eliminated.  Magic, right?  Wrong.  It doesn't work.   It is malpractice to suggest it.  Strong letter to follow.

[shERPA]

What Mike said.   The contracts have to be valued at fair market value, not CSV.   

[Bird]

I'm not an actuary but I actually believe it is legit in the sense of reducing the FMV of the asset.  Annuities are legitimately worth less than their purchase price immediately after the purchase due to the surrender charge, and FMV is equal to or pretty close to surrender value.  The fact that the surrender charge eventually disappears isn't particularly relevant b/c the contract basically sucks; recovery of the surrender charge takes place over a period of years and it's not like the gains are unusually large b/c of the disappearing surrender charge.  (In large part because the expenses are higher in order to recover the upfront commissions paid.)  All of this assumes it is not some variant of a springing value contract.

Not to say this is a good idea - what I usually say when presented with some variation of this is:   instead of doing that, how 'bout if I just charge you $10,000 (or whatever) in fees?  (Unfortunately that sometimes need more explanation but they eventually get the point.)

[jim241]

They're trying to use the surrender charge to get below the 415 limit. The annuity would be valued using FMV. 

[jim241]

The plan is terminating and the benefit of a participant is above the 415 limit. The thought is to buy an annuity that would be FMV, more expensive than the normal payout - which would reduce the assets in excess of 415 below the threshold. It's not a life insurance purchase. 

[Mike Preston]

There are two circumstances where what you have described actually works.  First, as Bird indicated, going to an insurance company and purchasing an annuity in the normal form will typically be more expensive than settling a participant's benefit in the form of a lump sum.  Second, going to an insurance company and purchasing an annuity in the form of a 100% joint and survivor benefit where the plan provides that the 100% joint and survivor benefit is fully subsidized is much, much more expensive than a lump sum.  The key to making it all work is that the insurance company, in both cases, offers a lifetime annuity.  There is no option to convert to a lump sum at a future date.

[ERISAAPPLE]

It seems to me you are just giving away 100% of the money to an insurance company instead of 90% to the government.  

[Mike Preston]

There are some real benefits associated with transferring mortality risk.

[ERISAAPPLE]

1 hour ago, Mike Preston said:

There are some real benefits associated with transferring mortality risk.

Why not just buy an annuity at a regular price and take the excess as a reversion?  Maybe I don't understand what is happening here.  

[Mike Preston]

I have no idea what you mean by "regular price".

[ERISAAPPLE]

I thought the proposal was to buy an annuity at an intentionally-inflated value in order to eat up the excess.  In other words, I thought they were trying to buy an annuity that is intentionally more expensive than necessary in order to use the excess above the 415 limits - giving the money to the insurance company instead of taking a reversion.    

[Mike Preston]

We appear to be in an infinite loop.

[Bird]

Insurance companies can't do off-the-cuff arrangements to sell single premium annuities so the concept of an intentionally-inflated price is not valid.  Breaking it down...

If a plan has $500K in cash and distributes it, it's worth $500K.

If a plan buys an annuity for $500K, the annuity is immediately worth less than $500K, due to surrender charges.  (This is largely due to commissions which are paid up-front, and recovered by the insurance company from annual fees, either direct or indirect.)  If the surrender charge is 6%, then the surrender value is $470K.  The fair market value, which is the relevant value for plan purposes, is probably a tad higher (because there is a slight chance of getting the purchase price - if the annuitant dies).  Now, there are many different products available within companies and by different companies, and you can certainly find one with a 10% surrender charge, but that is due to a higher commission paid to the agent.  So, however you do this, congratulations - you have reduced the value of something by giving some of that value to an insurance agent and insurance company.

[Mike Preston]

4 hours ago, Bird said:

Insurance companies can't do off-the-cuff arrangements to sell single premium annuities so the concept of an intentionally-inflated price is not valid. 

Effectively untrue.  Insurance companies have been known to develop boutique policies.  Do a google search on "springing cash value".

[Bird]

I understand about springing cash value policies.  But insurance products have to be registered and approved (they were).  I'm saying you can't go to an insurance company and cut some kind of special deal as was being implied.

[Belgarath]

I'll let Bird speak for himself, but I suspect he may have meant that the insurance company can't just randomly offer any old arrangement they feel like - policies generally have to be approved by the State Banking and Insurance Departments, which requires policy language, assumptions, filings, etc., etc. -

All right, I see he already did!

[ERISAAPPLE]

On ‎3‎/‎16‎/‎2018 at 11:56 AM, jim241 said:

I think the intent is to have the plan purchase an annuity in order to "eat" some of the assets to get below the 415 limits. 

There is no question that when you go out and buy an annuity from a commercial provider, the cost of the annuity is generally going to exceed the lump sum hypothetical account value calculated by the actuary.  There is also no question that the determination of the annual benefit is measured by the amount paid under the annuity contract, without regard to the expense of the contract itself.  Are you asking if the plan can buy an annuity instead of paying the lump sum and pay for the expense of that annuity with the excess assets?  The answer is yes.  I think what is confusing me (and maybe others who responded to this question) is why anyone would intentionally pay the extra cost for the annuity solely because they want to eat up the excess assets.  If they want to pay the extra expense to transfer the mortality risk (as Mike Preston suggested), that is one thing.  But to pay the extra expense for the sole reason of finding some way to spend the surplus does not seem to be rational economic behavior.  There are plenty of other things you could do with that money instead of handing it over to an insurance agent just to get rid of it.  That dovetails back to what David Rigby suggested.  If the plan is trying to game the system with something like a springing cash value or wear away of the surrender charge, I think everyone agrees that is not going to work; such an arrangement does not, however, seem to be the intent here.