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Can a nonqualified plan purchase annuities for retirees?


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A client has a nonqualified defined benefit top hat plan informally funded with a rabbi trust.

The client has decided that it would like to further address the benefit security issue by actually purchasing immediate annuity contracts at the time an employee retires. The present value of the benefit would be fully taxed at that time (and grossed up for taxes).

Until the annuity is purchased the employee would be an unsecured creditor of the company. The plan would be written so that once an annuity is purchased the employee would no longer be a participant in the plan and all benefit obligations would be satisfied solely by the annuity contracts.

Does this design raise any ERISA funding issues? I'd like to take the position that it does not, that the plan remains an unfunded top hat plan and that employees have a tax impact only when the annuities are purchased.

Could annuities be purchased with rabbi trust assets? Or would it be preferable for the employer to purchase the annuities (reimbursed through lower rabbi trust contributons).

Any thoughts would be appreciated.

r.

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Guest EAKarno

All that you have really done here is make a lump-sum distribution in the form of an annuity rather than cash. The participant is cashed out for all intents and purposes. Thus, the annuity shouldn't raise any ERISA concerns so long as it was only purchased at the time it was distributed. The cost of the annuity could either be paid out of the rabbi trust directly or by the company while reducing future contributions to the trust. It might be more tax efficient to pay with company assets rather than disturb ongoing plan investments.

As an alternative to the plan described, the company could buy an immediate annuity that names the trust rather than the participant as the beneficiary. If the participant has no indices of ownership, the benefit remains unfunded and tax deferred until actually paid. The annuity payments would flow to the trust, the trust would then pay the same amount to the participant. This would eliminate the need to pay the participant for the gross-up.

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Also note that this is settlement under SFAS No. 88 accounting rules.

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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EAK-

Thanks. Purchasing the annuity through the trust doesn't solve the security problem in the event of the employer's bankruptcy. The employer feels that employees should have as little risk as possible with respect to their excess pension benefit, and that the distribution of the annuity contracts is the best way to accomplish this.

Thanks again-

r.

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Guest wmacdonald
Originally posted by card

A client has a nonqualified defined benefit top hat plan informally funded with a rabbi trust.

The client has decided that it would like to further address the benefit security issue by actually purchasing immediate annuity contracts at the time an employee retires.  The present value of the benefit would be fully taxed at that time (and grossed up for taxes).

Until the annuity is purchased the employee would be an unsecured creditor of the company.  The plan would be written so that once an annuity is purchased the employee would no longer be a participant in the plan and all benefit obligations would be satisfied solely by the annuity contracts.

Does this design raise any ERISA funding issues?  I'd like to take the position that it does not, that the plan remains an unfunded top hat plan and that employees have a tax impact only when the annuities are purchased.  

Could annuities be purchased with rabbi trust assets? Or would it be preferable for the employer to purchase the annuities (reimbursed through lower rabbi trust contributons).

Any thoughts would be appreciated.  

If benefit security is your main concern, there are a number of alternatives that can provide the protection, without purchasing an annuity, which I think is costly. We have two alternatives for bankrupcy protection, both are proprietary, so I will discuss them off line if you would like. Call me at 213-438-6300.  

r.

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