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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? 

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Let me guess, there is an insurance agent involved?

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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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.

 

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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.  

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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. 

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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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.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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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.  

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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.

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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.

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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.)

Ed Snyder

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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. 

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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.

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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.    

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