Overview: What distinguishes a retirement plan, which is Benefit Focused from one that is Lump Sum Focused (such as the traditional split funded insured defined benefit plan?) A Benefit Focused Plan provides no distribution or cash out of the lump sum value of the participant’s monthly retirement benefit. This restriction of no cash out permits the plan:
- to fund to a more valuable benefit, i.e. a 100% joint and survivor monthly retirement benefit;
- to provide a death benefit of 100 times the monthly pension until the death of the participant while the surviving spouse continues to receive the participant’s monthly benefit (vs. the traditional split funded plan where the insurance death benefit must end at normal retirement age), and;
- to protect the value of this benefit from estate tax since there is no distribution of this value (vs. the traditional split funded insured defined benefit with a single life annuity and a cash out at retirement).
The fundamental plan provisions of the Benefit Focused Plan, which are backed by IRS letters of determination and include the most recent restatements, are what distinguishes the Benefit Focused Plan from Lump Sum Focused Plan. They include the following:
- The Benefit Focused Plan provides a completely subsidized 100% joint and survivor monthly annuity. This and a life annuity are the only form of retirement benefit that the Benefit Focused Plan
- There is no cash out of the participant’s present value of the accrued benefit. There is no lump sum right of the participant to receive a distribution of cash other than as a monthly retirement benefit. This is a major plan provision difference from the Lump Sum Focused Plan which provides a single life monthly annuity and cash out of the value of the accrued benefit. As a result, there is no cash out when a participant terminates or retires. This provision is necessary in order for a plan to fund for a normal form of a 100% joint and survivor annuity. Internal Revenue Code (IRC) Section 415 specifies that if a participant has a cash out option, the participant’s present value is based on the value of a single life annuity. Since a 100% joint and survivor monthly annuity is more valuable, there can be no cash out option to the participant so that he is eligible for the more valuable benefit.
- The death benefit provision of the Benefit Focused Plan is also different than the Lump Sum Focused Plan. In either plan, in order for a participant to be eligible for a death benefit, it must be incidental (not greater than 100 times the participant’s projected monthly retirement income) to the primary purpose of the plan, which is to provide a monthly retirement income. In the traditional plan, this benefit is available until normal retirement at which time the benefit is terminated. In the Benefit Focused Plan, this incidental death benefit is available to all plan participants whether active (on a pre-retirement basis) or retired (on a post retirement basis). This incidental death benefit continues until the death of the participant. However, this benefit ceases if a participant is terminated.
- The plan document provides that there is no reduction in the IRC Section 415 (b) benefit limit because of the availability of an incidental death benefit for a plan participant. IRC Section 415 (b) governs the maximum benefit limits available to a plan participant and stipulates that incidental ancillary benefits do not affect the level of the benefit available to a plan participant.
- These plan provisions are within all the regulatory guidelines and are reinforced by the Pension Protection Act (PPA) and implementing regulations. PPA now requires the enrolled actuary to value both the present value of the retirement benefit and the present value of the incidental death benefit, adding them to determine the total Funding Target. The Benefit Focused Plan, under these new valuation guidelines, now provides a substantially larger deduction than the Lump Sum Focused Plan. This deduction is larger because we are funding to a 100% joint and survivor monthly retirement benefit plus an incidental death benefit continuing to life expectancy of the participant. This contrasts with the Lump Sum Focused Plan with an incidental death benefit ending at normal retirement age.
- The plan document requires two trustees: a “participant trustee” (usually the business owner of the plan sponsor) and a “non-participant trustee” (one who is independent and is not a family member or beneficiary of the participant trustee or the plan sponsor.) These trustees are co-trustees with equal powers, duties, and responsibilities. However, the non-participant trustee has sole power over all insurance matters and control over a separate checking account. He uses this account to pay the insurance premiums and receives the death proceeds as the beneficiary of the respective policies. This arrangement walls off any incidence of ownership or power from the participant trustee.
- The plan document does not give the participant the right to name his or her beneficiary, providing instead for a hierarchy of beneficiaries that the non-participant must follow. First is the spouse, satisfying the provisions of The Retirement Equity Act of 1984 (REA) that the surviving spouse is protected by being the first beneficiary. The second beneficiary is defined as a “trust of the participant.” The third beneficiary, if there is no trust, are the children per stripes of the participant. Finally, if there are no children, the fourth beneficiary is simply the participant’s estate.
Jodie Dailey is a co-contributor to this press release.