The Section 419 market continues to stimulate some of the most creative plan designs in the life insurance business. This article looks at some of the most recent strategies and the implications for advisors.
To understand the present market, it is helpful to review its history.
Section 419 came into being under the Deficit Reduction Act of 1984. Its purpose was to close loopholes that were then perceived as allowing employers to accelerate deductions for welfare benefit plans–providing life insurance, retiree medical benefits, etc. Even the DEFRA Conference Committee report mentions that the goal was to prevent employers from taking premature deductions such as with a premium stabilization account.
In the ensuing years, the market has produced one type of Section 419 plan after another and another. Each focused on exceptions to the rules. As the Internal Revenue Service shut down versions it perceived to be abusive, the marketers came out with new versions.
This migratory history gave rise to the so-called multi-employer (over 10) plans (Section 419A(f)(6) plans). But when new IRS regulations essentially stopped abuses it perceived in those plans, promoters moved on to another exception under Section 419A(f)(5). This section targeted collectively-bargained plans, but the IRS later moved to close loopholes with these plans too.
In recent times, marketers have turned to the single-employer plans allowed under Section 419 in the first place. (Note: These plans were subject to limitations that marketers originally sought to avoid with multi-employer plans and collectively-bargained plans.)
It is these single-employer plans that are creating the buzz today.
Under Section 419, the deduction is limited to the “qualified cost.” This refers to the “qualified direct cost” for the benefits provided during the taxable year, plus any addition to a reserve for retiree benefits. The deduction may not exceed the amount that is a reasonable and necessary business expense under Section 162.
Due to limitations in the amount of benefits that can be reserved, and the non-discrimination rules that apply to retiree medical benefits, most of the efforts in the single employer market have tended to focus on pre-retirement life insurance.
The approach goes like this: The employer sets up a Section 419 plan that provides just pre-retirement life insurance. The employee includes in income the value of the annual life insurance benefit, usually under Table 2001. So, if the employer’s annual deduction equals the Table 2001 cost, there is probably no reason to have a Section 419 plan for this benefit. To make the plan more attractive, the employer may decide to fund the cost of the pre-retirement life insurance on a level annual basis over the participants’ lifetimes.
For example, if an employee enters the plan at age 50, and if age 65 is the normal retirement age, the employer figures out what the total cost of the benefits will be over all the years and then levelizes the cost so that it is the same for each year.