BY

In light of recent proposed guidance from the Internal Revenue Service on 412i plans, advisors may be wondering whether they should consider 419A(f)(6) plans for certain clients.

Section 419A(f)(6) permits employers to provide welfare benefits (death, severance, disability income, long term care, etc) in an employee benefit program where 10 or more employers opt into a compliant plan. These assets are owned by the trustee for the benefit of the participants. Employers’ annual contributions are based on the amount needed to pay for the benefits and are income tax deductible so long as the benefits are reasonable. Since the benefits typically are designed to be paid upon the occurrence of certain triggering events that are beyond the participants’ control, these benefits are not subject to the qualified plan rules.

These welfare benefit plans are not designed for retirement benefits, whereas 412i plans are.

A 412i plan is a qualified defined benefit pension plan funded exclusively by either life insurance or annuity contracts or a combination. 412i plans must satisfy certain criteria in order to be exempted from the complex funding rules that apply to traditional defined benefit plans. There has been a significant difference of opinion over the amount of life insurance and type of product which could be placed into a 412i plan without running afoul of the Code and IRS guidance.

An employer may sponsor both welfare benefits and retirement benefits concurrently, i.e. 419A(f)(6) and 412i plans.

While 412i plans still are viable when properly designed, advisors should look seriously at the 419A(f)(6) market, conduct their own due diligence and work with a plan sponsor and carrier that will not abandon them in these challenging times. This is easier said than done.

Here are some questions to pose:

–Has the 419 plan ever been audited and did these audits result in material changes?

–What is the size of the plan and how long has it been in existence?

–Has the plan sponsor rescued other now-defunct 419 plans?

–Has a national reputable law firm reviewed and provided a comprehensive more likely than not opinion on the sanctity of the plan and all its components?

–Is the plan independently audited each year and has the plan received pristine unqualified reviews?

–Did the plan have to undergo wholesale changes after the July 2003 final regulations were published?

–Have the plan and the producer been challenged in court and, if so, what is the status of this litigation? Bear in mind most suits settle with confidentiality agreements so you will have to press to learn whether the claims were meritorious.

An advisor cannot automatically switch a client seeking a retirement benefit plan to one providing welfare benefits. Nevertheless, there undoubtedly have been many producers focusing too heavily on the 412i marketplace and who, for whatever reasons, have not presented or explored 419 plans.

A conservative financial advisor can and should fully explain the attendant risks associated with any 419 plan, which include the enticing element of the deductibility of the premiums paid into the plan. However, if this is the only rationale for entering into the 419 plan, then the client has been shortchanged and the producer is vulnerable to a misrepresentation claim, due to omission.

Carriers frequently insist on written acknowledgments from the client and producer of all tax risks at the point of sale. This equates to a shifting of risk of any tax law changes upon the client and, consequently, to the producer if this disclosure is not explained.

Clearly, the IRS has sought to “discourage” clients, plan sponsors and carriers from overselling 412i plans designed to be tax deductible when premiums are paid and permit tax free loans upon exit. Certain producers oversold the magic of entering and exiting a 412i, which flew in the face of the congressional intent behind these defined benefit plans.

419 plans are not a panacea; however, the range of ideal prospects is wider than one might think. They include small to medium-sized businesses of any industry or even a business with multiple entities; a client who has a need for life insurance, asset protection from creditors or need for a retained earnings solution; a client seeking to attract, retain and reward key employees; and a client with the need for independently trusteed severance benefits.

Can you imagine the number of employees who have suffered from the Enron collapse who would have not had their lives so disrupted if a comprehensively designed 419 plan had been in place?

Is there a possibility the IRS may seek to curb abuses that might arise in the 419A(f)(6) marketplace? This is a risk of which producers must always be aware, but as long as they have been prudent and conservative in enrolling a client in one of these plans with a seasoned plan sponsor and financially strong carrier, this risk becomes no more or less than one takes in dealing with the public?s finances in this era of heightened scrutiny over ethical behavior.

, JD, CLU, ChFC, is president of Friend Financial Group, LLC, Texas. His e-mail address is Ross_Friend@aigag.com.


Reproduced from National Underwriter Edition, April 2, 2004. Copyright 2004 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.