Pre Retirement Death Benefit Eligibility Conditions

[Guest meggie]

A nonelecting church defined benefit plan is considering adding a pre ret death benefit that will be payable upon the death of a single parent (participant) to children (under the age of 23). The plan already has the std "REA" pre ret death benefit for marrieds.

Question: Can the plan include this additional death benefit? Can the benefit be more genereous than the "REA" death benefit? Also note that(1) single participants or (2)single parent participants with children over the age of 23 would not be eligible for any pre- ret death benefit under the plan.

I can't seem to find any IRS/ERISA references that would disallow such a feature. Of course the benefits would have to be tested if there were HCEs in the plan (Presumably there are no HCEs).

Although my recommendation would be to stay away from such a feature and go with term insurance (instead), I can't seem to find any regulatory reference that would forbid this.

Meggie

[AndyH]

Sure it could be more generous. Why would you think not? Many plans covered by ERISA have much more generous death benefits. The main limit is that the death benefit be incidental to the retirement benefit. The limit would be multiples of the REA death benefit.

Since it's a non-electing Church plan, it may not even be subject to the incidental death benefit limits (off hand, I'm not sure).

I don't, nor I trust would many others in this field agree with your suggestion that the client would find term life insurance more cost effective than providing that benefit through the plan, for a number of reasons, one being that the insurance company needs to make money, and another that it would subject the participant to PS-58 costs.

[Guest meggie]

Thank you for your reply, AndyH. Are you saying that term insurance is not the cheapest way to go? I'm just asking as I have been told by another pension consultant that it is fairly cheap. Can you expand on the PS58 costs?

My concern, is to avoid creating complex conditions and/or benefit formulas for an incidental death benefit within the pension plan. The client does not want to provide a "REA" type death benefit to all participants through the pension plan as that is too costly. That is the reason why they are considering the various eligibility conditions as noted earlier to strip out some people.

Thanks.

[AndyH]

Sorry for the delay in responding. It's that time of year.

First, a REA type death benefit is very cheap. We're talking about maybe 40% on average of the pension value in the event of death. I'd first suggest that you have the actuary handling the case cost out a "similar" (REA-like) death benefit. For example, the beneficiary of an unmarried participant gets 45% of the present value of the participant's accrued benefit. You'll be surprised by how low the cost is.

This assumes that the actuary has software that can handle this calculation. If not, they can provide an estimate. You will be surprised how low the cost is. The conditions you've added will save a small percent of a small amount. I wouldn't bother.

As to insurance, the benefit you're talking about is small. Any benefit which can be provided by insurance can be self insured. Outsourcing it to an insurance company will add the element of administrative costs and profits. This assumes a perfect insurer (I'm being kind to them). I'm not an insurance expert, but common sense tells me that the dollars you are talking about could be easily handled from self insuring, thus avoiding margin, profits, commissions. I would only outsource this if the trust could not easily absorb a couple of deaths. But, you are talking about small dollars.

P.S. costs are amounts participant must include in their taxable income as a result of the "economic benefit" they derive from insured death benefits. The easiest way to think of this is that the participants pay taxes on the insurance premiums. The actual figures are different. I recently had a client with group term insurance whose P.S. 58 costs were actually 3 times the premium! The figures come from IRS tables. In place of the table, you can use figures from the insurer which is based upon a 1 year term product which is commercially available (or some technical language like that-I don't have it with me). This definition isn't technically precise, but the point is that participants need to pay taxes on insured death benefits. If you provide a death benefit which is a function of the accrued benefit, I don't think that applies.

Surely someone will point out that there is a tax benefit derived from paying the PS 58 costs, in that the death benefit is then free from taxation. You can look into this, but my advice remains that it is not worth it.

(I'm not certain where the line is drawn for when PS 58 costs apply in a self insured environment, maybe a board member can help me with this).

Hope this helps for now. Think in terms of profits for insurers and check out PS 58 cost tables as issued by the IRS. I think that whoever told you term insurance is the way to go is either not experienced in such matters or has an "economic benefit" derived from such advice.

[Guest PAUL DUGAN]

Andy gave you a great answer I agree with ever thing he said.

To answer his one question, my 15 years as an insurance agent selling pensions plus 20 more years as a pension consultant, I believe that PS 58 cost would apply to any death benefit that exceed the value of earned pension benefits insured or not.

[Guest meggie]

Thank you both for your reply and interest in helping me out with this situation.

Can I sum things up by saying that as long as there is no violation of the incidental death benefit rule and appropriate non discrimination testing is done, that the plan can have one or different pre ret death benefit formulas that can be paid out to the spouse, or to a minor child (under age 23)if not married? If single and no minor children as described, then there is no death benefit payable. Thanks again.

[AndyH]

I think that is an accurate statement. Good luck.