Advisors Debate Whether 419 Plans Are Worth The Risk
While recent tax court cases have allowed the continued use of Section 419 plans, some practitioners feel that the risk of an unfavorable court ruling far outweighs the rewards the plans offer. Others continue to endorse 419 plans.
In its most basic form, a 419 plan allows an employer to provide selected employees a current benefit on a tax-deductible basis. The employer makes contributions to a multiple employer trust, which funds these benefits with permanent life insurance policies.
“419s are not against the law,” said Lawrence Bell, senior counsel, advanced markets for BISYS-Potomac, in a debate on 419 plans at the LIMRA Advanced Sales conference here. “You can do them if you dot your is and cross your ts.”
Bell said the problem people run into with these plans is that if there is an expectation of distribution, the IRS will treat it like a deferred compensation plan.
“If someones going into a 419 plan for a retirement benefit, then its not a good investment,” said Bell.
Under current practice, 419 plans are predominantly being marketed as death benefit only plans. Some experts feel that these plans also carry a cash reward for executives, and are more appropriately considered to be deferred compensation plans.
“419 says you can get a contribution deduction for providing a current benefit,” explained Bell.
“A life insurance policy is a current benefit,” he continued. “The amount of the deduction is the cost of the current death benefit.
“A cash value life insurance policy over the working life of an employee is a more cost-effective way to provide a benefit at the employer level than a term policy over that same working life,” said Bell.
Some experts, however, feel that the 419-plan approach is a little too aggressive, and promoters are reading much more into the law than was intended.
“There are a number of reasons for not doing 419 plans,” said Timothy Wuestenhagen, senior policyholder tax counsel, Securian Advisor Services/Worthmark Financial Services, LLP, a division of Minnesota Life.
“The first one is IRS challenges,” he said.
“Were aware that the IRS is aware of these 419 plans and I think you can bet that as 419 plans evolve and promoters get more ingenious with these plans, the IRS is going to continue to challenge them,” said Wuestenhagen.
“So anybody whos out there promoting these can probably expect continued challenges from the IRS,” he warned.
Wuestenhagen believes that while promoters are implementing these plans as death benefit only plans, “theyre using it more like a severance plan.
“If the insured dies, then the plan works as intended,” he said.
Wuestenhagen noted that if the insured does not die, there may be some issues around termination. “Distribution has to be due to termination of the employee, or the plan,” he said.
“I actually agree,” said Bell. “Its not a good investment unless youve got a death benefit need.
“If theres a current death benefit need, for buy-sell or prepayment of estate taxes, then its something that should be considered,” said Bell.
“As a supporter of 419,” argued Bell, “a severance benefit qualifies, but would I do it? No.”
“My point is the rewards to this may not cover the risk,” said Wuestenhagen.
“Another aspect that I focus on,” he said, “in respect to those used as severance plans, is how they stack up against section 162 bonus plans.
“If someones promoting the welfare benefit trust and showing you that there can be a distribution upon termination of the plan, with a 162 bonus plan you can end up in the same place,” said Wuestenhagen.
“The bet is that at termination the executives tax rate is lower,” he explained. “But how is that going to happen if youve got a heavily funded plan where the policy is coming out and theres $2 million of cash value?”
He continued, “How are you going to get into the lowest tax bracket at terminationyoure never going to do it, youre going to be in the top tax bracket.”
Wuestenhagen went on to compare a 419 plan funded to the MEC level with a 162 plan purchasing a policy with after tax dollars.
He illustrated an example where he showed the discounted value to the employee to be about a $4,000 difference in favor of the 419 plan. “My point is the rewards to this may not cover the risk,” he said.
“There are potential IRS challenges to the plan, potential unfavorable court rulings, administrative fees, lost control of the assets, and then theres all the plan termination issues,” said Wuestenhagen.
“The last point is, if the after tax discounted return is equal, does this justify the risk?” he asked.
Bell concluded his perspective saying, “419 is a tool, its a plan. For death benefit funding with a multigenerational company, where there can be continuing liquidity needs, its something to look at.”
Reproduced from National Underwriter Life & Health/Financial Services Edition, December 10, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.