Jul 30, 2009

DEATH AND DISABILITY BENEFITS

Qualified plans are intended primarily to provide retirement benefits or, in the case of profit-sharing and similar plans, deferred-compensation benefits. However, the regulations indicate that a plan may provide for the payment of incidental death benefits through insurance or otherwise, and also that the plan may provide for the payment of a pension due to disability. Moreover, a qualified plan must in certain circumstances provide a survivorship pension to the participant's spouse.

Currently under Code Section 401(a)(11), two types of survivorship benefits are required: the qualified joint and survivor annuity and the qualified preretirement survivor annuity. All pension plans must provide these, but profit-sharing plans need not provide them if the participant's vested account balance is payable as a death benefit to the spouse. ESOPs and stock bonus plans generally do not have to provide spousal survivorship benefits.

Qualified Joint and Survivor Annuity
The qualified joint and survivor annuity is a postretirement death benefit for the spouse. Plans subject to this requirement must provide, as an automatic form of benefit, an annuity for the life of the participant with a survivor annuity for the life of the participant's spouse. The survivor annuity must be not less than 50 percent of nor greater than the annuity payable during the joint lives of participant and spouse. The spouse annuity must be continued even if the spouse remarries. The joint and survivor annuity must be at least the actuarial equivalent of the plan's normal form of benefit or any optional form of benefit offered under the plan.

The qualified joint and survivor form must be offered automatically to a married participant at retirement. The participant may elect to receive another form of benefit if the plan so provides; however, the spouse must consent in writing to the election and the consent form must be notarized or witnessed by a plan representative. An election to waive the joint and survivor form must be made during a 90-day period ending on the annuity starting date. A waiver of the joint and survivor annuity can be revoked—the participant can change the election during the 90-day period. The plan administrator must provide the participant with a notice of the election period and an explanation of the consequences of the election within a reasonable period before the annuity starting date.

Preretirement Survivor Annuity
Code Section 401(a)(11) mandates a preretirement death benefit for the spouse of a vested plan participant. The survivor annuity payable if the participant dies before retirement is the amount that would have been paid under a qualified joint and survivor annuity, computed as if the participant had either (1) retired on the day before his or her death or (2) separated from service on the date of death and survived to the plan's earliest retirement age, then retired with an immediate joint and survivor annuity. For a defined-contribution plan, a qualified preretirement survivor annuity is an annuity for the life of the surviving spouse actuarially equivalent to at least 50 percent of the participant's vested account balance as of the date of death.

As with the qualified joint and survivor annuity, a participant can elect to receive an alternative form of preretirement survivorship benefit, including a benefit that does not provide for the spouse. However, written consent by the spouse is required for such an election. The right to make such an election must be communicated to all participants with a vested benefit who have attained age 32, and the participant can elect to waive the preretirement survivor annuity at any time after age 35.

Subsidizing Survivor Annuities
A plan can provide that a participant who receives either the qualified joint and survivor annuity or the preretirement survivor annuity will receive an annuity payment lower than the amount that would be paid under a straight-life annuity; the reduction reflects the extra cost to the plan of the survivorship feature. For example, the normal form of benefit might be a straight-life annuity of $1,000 per month, but the joint and survivor annuity might pay only $800 per month while both spouses survived, then $400 per month to the survivor. However, a plan is permitted to subsidize all or part of the cost of the survivorship feature. If the survivorship feature is fully subsidized, the plan does not have to allow the participant to elect an alternative form of benefit.

Incidental Death Benefits
A qualified plan may provide a death benefit over and above the survivorship benefits required by law. In a defined-contribution plan, probably the most common form of death benefit is a provision that the participant's vested account balance will be paid to the participant's designated beneficiary in the event of the participant's death before retirement or termination of service. Defined-benefit plans, unless they use insurance as discussed later, usually do not provide an additional death benefit; in such cases, the survivors receive no death benefit except for whatever survivor annuity the plan provides.

To provide any substantial preretirement death benefit, it is usually necessary for the plan to purchase life insurance. This provides the plan with significant funds at a participant's death; it is particularly important in the early years of a participant's employment, when the participant's accrued benefit is still relatively small. An insured preretirement death benefit can be provided in either a defined-benefit or defined-contribution plan. Contributions to the plan by the employer may be used to pay life insurance premiums, as long as the amount qualifies under the tests for incidental benefits.

In general, the IRS considers that nonretirement benefits such as life, medical, or disability insurance in a qualified plan will be incidental and therefore permissible, as long as the cost of providing these benefits is less than 25 percent of the cost of providing all the benefits under the plan. In applying this approach to life insurance benefits, the 25 percent rule is applied to the portion of any life insurance premium that is used to provide current life insurance protection. Any portion of the premium used to increase the cash value of the policy is considered a contribution to the plan fund available to pay retirement benefits and is not considered in the 25 percent limitation.

The IRS has ruled, using its general 25 percent test, that if a qualified plan provides death benefits using ordinary life insurance (life insurance with a cash value), the death benefit will be considered incidental if either (1) less than 50 percent of the total cumulative employer contribution credited to each participant's account has been used to purchase ordinary life insurance or (2) the face amount of the policies does not exceed 100 times the anticipated monthly normal retirement benefit or the accumulated reserve under the life insurance policy, whichever is greater. In practice, defined-benefit plans using ordinary life insurance are usually designed to take advantage of the 100-times rule, while defined-contribution plans, including profit-sharing plans, that use ordinary life contracts generally make use of the 50 percent test.

If term insurance contracts are used to provide the death benefit, the 25 percent test will be applied to the entire premium, and the aggregate premiums paid for insurance on each participant should be less than 25 percent of aggregate additions to the employee's account. Term insurance is sometimes used to fund death benefits in defined-contribution plans but rarely in defined-benefit plans.

The discussion so far is somewhat simplified because insurance can be used in qualified plans in many ways, and the IRS has issued many rulings, both revenue rulings and letter rulings, applying the basic 25 percent test to a variety of different fact situations. Thus, there is considerable room for creative design of life insurance-funded death benefits within qualified plans.

If life insurance is provided for a participant through a qualified plan (i.e., by using employer contributions to the plan to pay premiums for the insurance), part or all of the cost of the insurance is currently taxable to the participant. Life insurance provided by the plan is not considered part of a Section 79 group term plan, and consequently the $50,000 exclusion under Section 79 does not apply.

If cash value life insurance is used and if all of the death proceeds are payable to the participant's estate or beneficiary, the term cost, or cost of the "pure amount at risk," is taxable income to the employee. The term cost is the difference between the face amount of insurance and the cash surrender value of the policy at the end of the policy year. In other words, the cost of the policy's cash value is not currently taxable to the employee because the cash value is considered part of the plan fund to be used to provide the retirement benefit.

Planning Considerations
It is relatively uncommon for a qualified plan to provide medical, disability or term life insurance to participants because the tax treatment provides no advantage to the employee in so doing. It is more common, however, to use cash-value life insurance as funding for the plan because the cost to the employee using the PS 58 table or the insurance company's term rates may prove to be a relatively favorable way to provide life insurance.

The decision whether to include life insurance in a qualified plan relates to the employee benefit design objective of efficiency. The employer must first decide whether and to what extent it will provide death benefits to employees. Death benefits can be provided for employees under group term plans and other plans as well as providing them as an incidental benefit in qualified plans. The death benefit should be designed to produce the lowest employer and employee cost for the benefit level desired. A death benefit should be included in the qualified plan only to the extent it is consistent with this objective.

Disability Benefits from Qualified Plans
A qualified plan may provide as an incidental benefit a pension payable upon disability. The plan must provide a specific definition of disability. Usually some minimum service or age requirements are imposed to appropriately restrict the class of participants entitled to the disability pension. The disability benefit may be the participant's accrued benefit actuarially reduced because of a commencement date earlier than normal retirement, or the plan may provide some subsidy of the disability benefit to be sure that it is adequate for the participant's needs.

It is becoming increasingly common for companies to cover disability through separate benefit programs, often insured. Such programs tend to be fairer and more efficient than providing disability coverage as an incidental benefit under a qualified plan. In all events, the planner should be sure that there is no duplication of disability coverage between the qualified plan and a separate short-term- or long-term-disability plan of the employer.

Qualified plans that do not provide immediate disability coverage prior to normal retirement age should, however, include some provision for the treatment of the employee's retirement benefit if the employee becomes disabled. Separate long-term-disability programs usually cease paying benefits when the participant reaches age 65 or other normal retirement age. After this age, the company's retirement plan must provide whatever income the participant will receive from the employer. Therefore, from an employee's standpoint, the plan should be designed so that the retirement benefit will be adequate when long-term-disability benefits cease. For example, the plan might provide that a participant who is disabled as defined in the plan will continue to receive service credit for purposes of vesting or benefit accrual, or both. The definition of disability in the plan should be coordinated with the definition in the employer's long-term-disability plan. The plan also should indicate what definition of compensation will be used to determine retirement benefits if the participant becomes disabled before retirement.

3 comments:

buyapension said...

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Jessica said...

An insurance disability lawyer can come to the rescue in such times to guide and counsel the individual through the process. A lawyer will make sure the proper documentation.

Wilson O'Doyle said...

Finding a reputable insurance agency can be a hard thing. People should always do there research and even try to compare different quotes and benefits if possible. Also choosing the right type of insurance whether it is Life Insurance or Long Term Disability.

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