419 Welfare Benefits Plans Reborn - New Regs Clarify Existing Law by Paul M. League, QFP, CFP

419 Plans, "arrangements" in government speak, are best known by employers for both the tax deductions & the benefits they provide. The key benefits of 419 Plans are most often the death & severance benefits to business owners & their valued employees, with the central advantage to business owners being the ability to use business entity resources (on a tax deductible basis), for the purpose of providing post retirement resources back to the individual (owner) at more favorable, reduced tax bracket levels.

Over the years, 419 Plan design abuses that resulted in benefits based solely upon death benefits, caused the government to recently issue these new regulations that, in reality, now merely provide clarifications to already existing law.

The new regulations at long last define a "welfare benefit" as benefits resulting from illness, personal injury, death of the employee, and involuntary termination of employment (severance). As was the case prior to these new regulations, there remains no regulation over the investments of a welfare benefit fund. What the new Regulation do not rule on are any kind of non-discrimination or participation requirements, though input is expected in the near future.

Historically, 419 Plans have used any number of funding vehicles to provide the benefits for which they are designed. For the most part, however, we typically find a combination of term or cash value life insurance (whole life, interest sensitive UL, or even variable or equity investment based VUL) as the central, if not the only, funding vehicle within such Plans.

New regulations, issued by the Treasury and IRS, clarify the governments concerns over how such arrangements use various forms of experience rating, especially, though not only, as such activity relates to death benefit only insurance funded Plans (i.e. such experience ratings as employer reductions in policy premiums by reallocations of plan assets on terminating employees, reductions to benefits based on investment results, etc.).

The government now clarifies the requirement that an employer's interest be more like that of an individual to an indistinct group, rather then that of an individual employer to its' own asset, so as to best assure that the employer & Plan are exempt from the deduction limits of Sections 419 & 419A, and by being so, meet the self-regulating 419A(f)(6) safe harbor rules. In the words of the IRS & Treasury, "these regulations generally clarify existing law", and are applicable to Plans to which contributions have been paid or are "incurred" beginning July 17, 2003 [the Final Regulations actual effective date: ß1.419A(f)(6)-1(g)], making it also clear that Plans in place prior to this final effective date need immediate re-examination. The new Regs do not prevent transferring from a non-compliant Plan to a compliant one.

The prohibition against individual employer experience rating essentially forces the employer to ask a rather practical and objective question; namely, would you, Mr. Employer, pay your hard earned dollars into a program where the contributions & benefits are not solely for your benefit, but are instead based on the experience of all other Plan employers (a specific employers asset Vs an indistinct group)? Experience rating can co-exist within 419A(f)(6) Plans so long as it is global, meaning, it is applied to the whole Plan itself (all employers), and not to any one Plan employer.

The new Regs require that 419A(f)(6) arrangements, which are designed to overcome the deduction limits, prove adherence to the new " experience rating Regs", not only through objective mathematical calculations & Plan documents, but also right down to marketing materials! Of course, the Plan must be maintained with a written document that also requires the Plan Administrator to maintain records for the IRS and any Plan employer, and that these be made readily available for inspection and/or copying by these parties.

Given both the applicability & inclusion of all that we have discussed above, it appears that as long as a 419A(f)(6) arrangement also consists of the following, one should be on "safe ground":

A 419A(f)(6) Plan "Arrangement" must consist of 10 or more separately distinct employers, with no employer contributing more than 10% of the total contributions, and must be non-experience rated.

Benefits are based upon non-discriminatory multiples of compensation.

Plan must provide for: fixed benefits, fixed coverage period, and at a non-excessive fixed price charged by the Plan.

No separate accounting by participating employer.

Experience rating must be PLAN-WIDE, not specific to any one employer (i.e. includes such experience items as claims, investment returns, funding expenses, etc.).

PLAN-WIDE separate accounting at plan termination and/or employer withdrawal.

When using Life Insurance as a funding vehicle is must be subject to Plan rules regarding cost of benefits, no separate accounting, and where costs must be based on current age and not age at date of policy issue, etc.

Death benefits are not determined by the amount of cash values in an employers group (i.e. segregating of assets by employer).

Employee death benefits are paid to a named beneficiary, never the employer.

Severance benefits are based upon uniform formula for all employees, with an independent actuarial certification that the formula is reasonable, and are only available for involuntary termination of employment, not death, illness or retirement (i.e. a welfare benefit based upon uncertainty, not the certainty of deferred compensation).

All assets of Plan are commingled - indistinct over the entire Plan.

Upon employer termination from the Plan, vested benefits are uniformly distributed, and are not based upon the benefits, or experience, of any one employer.

In conclusion, any 419A(f)(6) Plan must not run afoul of the only slightly modified "5 suspect characteristics" (no allocation of assets to a specific employer; benefit costs can not vary by employer; fixed benefit, coverage & price; no excessive charges for covered risks; only benefits are illness, injury, death or involuntary termination), and the special rules regarding life insurance (values of insurance contacts must be treated as values of the Plan and not any single employer), but must also meet the form and substance of these clarifying Regulations. This is another way of saying that in practice the Plan must be able to demonstrate that it is not simply a scheme for tax deferral without the purpose of providing actual employee welfare benefits. The government will not allow for Plans that do not provide such benefits, and are instead really just a disguised nonqualified deferred compensation or constructive dividend scheme.

We trust that the above does indeed clarify many of the questions and concerns surrounding 419 Plans. Clearly, compliantly designed & properly Administered 419 Plans, can still deliver significant advantages to business owners and their employees. Large tax deductions, tax deferral, and meaningful pre & post plan benefits, compel most employers to consider establishing such Plans as terrific additions to further augment such other benefit plans as traditional Pension Plans (Defined Benefit, 412(i), 401(k), New Comparability Profit Sharing Plans, etc.), as well as many other employee benefit plans.

We provide solutions, that comply in both form & substance, to help you, and your professional advisors, meet the challenges posed in these & other government Regulations.

Disclaimer Notes: The material discussed is meant for general illustration or informational purposes only and is not to be construed as investment or tax advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. We do provide tax or legal advice (10/03)]. ©Paul M. League/LFIS. All Rights Reserved.

Paul M. League, QFP, CFP® is the principal of League Financial & Insurance Services / LeagueFinancial.com, and a registered representative and investment advisor representative with Royal Alliance Associates, Inc., Member NASD/SIPC, a Broker/Dealer & Registered Investment Advisor. Paul has specialized in wealth creation, preservation, and expansion through individual and group benefit programs for over 20 years. He can be reached at 332 S. Beverly Drive, Suite #101, Beverly Hills, CA 90212, phone (310) 277-3141; www.LeagueFinancial.com ;E-mail: Paul@LeagueFinancial.com.