You have probably heard of an agent who has made a large amount of money by marketing the latest and greatest concept, only to find out the sales concept has not stood the test of time. If you’re like many agents today, you have not taken an active role in marketing the single employer welfare benefit (SEWB) plans because you are waiting for more clarity.
Let me start by defining what types of benefits are addressed in ? 419 of the Internal Revenue Code (IRC). The benefits include welfare benefits, of which examples are health/medical benefits, life insurance/death benefits, disability benefits, severance and supplemental unemployment benefits.
All of these benefits tend to promote a social good. That is why our government has passed legislation to allow private employers to take tax deductions for contributions made to fund these benefits.
Are there different rules for each of the benefits provided? Yes. This is the result of legislators recognizing potential abuses and addressing them with legislative restrictions. For example, employers are limited in how much (if anything) they can deduct for contributions to fund a severance benefit. This is particularly true in cases where an employer previously provided no severance benefits.
Because there are too many plans to address each individually, let me identify the three “types” of plans being marketed today:
? Plans that have very little basis in the Internal Revenue Code and rely almost exclusively on interpretation;
? Plans that have some rationale provided by the IRC but still rely on interpretation; and
? Plans that are well defined in the IRC and rely on relatively little interpretation.
Regarding the first type of plan, the old adage “if it seems to be too good to be true, then it probably is” seems appropriate. Many times this plan type promotes a form of hidden (wink/wink) deductible, deferred compensation. I reference the hidden aspect because the promoters generally say, “This is not a deferred compensation plan,” but then proceed to illustrate a retirement income stream as part of the presentation.
The Internal Revenue Service has a long history of litigating this plan, and there is no reason to believe it will not continue doing so in the future. The plan very clearly does not meet the spirit of the Code.
The second type of plan has a lower tax risk but is not for the client who is faint of heart. The most common type of plan that falls into this category is often referred to as a pre-retirement death benefit-only plan. The attractive marketing story is the ability to fund a life insurance need with tax-deductible dollars.
Most of these programs allow for discrimination, so you can cover a select few along with one or two non-highly compensated individuals to keep the plan from running afoul of the U.S. Department of Labor’s top-hat rules. This can be particularly useful when used with a separate buy-sell arrangement, or to replace income that will be lost due to premature death. Some plans promote this as a way to fund estate liquidity needs, as well, although there is some question as to the effectiveness of this approach.
Although death benefits are a permissible benefit, determining what contribution can be deducted (known as the qualified direct cost) is subject to interpretation. Some plans advise that only a term premium is deductible, while others identify whole life premium as deductible.
In reality, the risk increases as the deduction rises. For clients who are aggressive in nature, and choose to participate in these plans, they should be aware they are assuming risk.
The third type of plan offers benefits that are subject to ERISA and must be provided in a non-discriminatory manner that will benefit all long-term employees. The benefits offered under this type of plan may be pre- and/or post-retirement medical benefits only, or they may combine pre- and/or post-retirement medical and death benefits. Although the IRC provides good guidance about this type of plan, some areas remain subject to interpretation.
For example, different plans offer different maximum benefit amounts. Many plans are based on independent actuarial calculations that are meant to provide the client with support if the client’s deduction is challenged.
Plans that offer post-retirement benefits on a non-discriminatory basis have been around for a long time, but they have been used primarily by large employers. As technology and administrative costs have declined, smaller employers are becoming consumers for these plans.
This is likely the result of escalating health care costs and the awareness of many baby boomers that medical expenses can be devastating to their retirement security.