What is it

1
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What is it?
• Rather than electing to receive a normal joint
  and survivor annuity from a pension plan, the
  retiring participant , with consent of spouse
  selects the higher single life annuity option
• The couple purchases a life insurance policy on
  the participant to assure financial security in
  the event the participant dies first and pension
  benefits cease
• The difference between the joint and survivor
  annuity and the single life annuity is available
  to pay premiums on the insurance
  
• When is the use of such a device indicated
• When more flexible survivor options than those
  provided by a qualified plans joint and survivor
  option are desired
  
• When the participants spouse is in poor health

2
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• When is the use of such a device indicated
  (cont'd)
  
• When the participants spouse has income and
  asset resources that can provide some of the
  spouses required income needs if the participant
  predeceases the spouse
• When the participant already has life insurance
  in place for his or her life that can provide the
  bulk of the surviving spouses retirement income
  needs in the event the participant predeceases
  the spouse
• Pension maximization strategy is more feasible
  if the participant is female
  
• Pension benefits based on unisex mortality
  factors
  
• Most life insurance policies priced according to
  sex-based factors
  
• Relative costs of survivor benefits acquired
  through insurance will be generally less than the
  cost of those same benefits acquired from a
  qualified plan

3
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• Advantages
• Planning flexibility
• Insurance feature of Joint Survivor (JS)
  annuity has several unattractive elements
  
• Participant will receive the lower JS benefit
  payments even if spouse predeceases participant
  and the survivorship feature is no longer needed
  
• Lack of flexibility with the JS annuity feature
• Only option is in the selection of the survivors
  ratio. The default ratio is 50, but election
  could include 662/3rd , 75 or even 100.
  
• As the survivor ratio goes up, the benefit
  typically goes down
  
• Pensioner has no rights to (1) accelerated
  benefit payments and (2) choose a substitute
  beneficiary if the spouse predeceases the
  participant or (3) wait to select what type of
  benefit payout pattern will be paid to the
  surviving spouse if the participant dies first

4
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• Advantages (cont'd)
• Pension maximization attractive because life
  insurance policy offers more planning flexibility
  
  
• Options if the spouse dies prior to the
  participant
  
• Keep policy inforce and name a new beneficiary
  (child, grandchildren, charity)
  
• Suspend premium payments and increase his/her
  spendable retirement income
  
• If the policy has cash value
• Elect the reduced paid-up or extended term
  insurance Nonforfeiture Options
  
• Surrender the policy for its cash value

5
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• Advantages (cont'd)
• Options for the surviving spouse
• JS annuity provides only one option life
  annuity
  
• If not in good health, surviving spouse can elect
  a higher benefit, limited and guaranteed term
  annuity
  
• Wait and see approach
• Set up a trust to receive the insurance proceeds
• Trustee is given discretion as to how to
  distribute the funds to best insure the surviving
  spouses financial security
  
• Payments could be accelerated to meet special
  needs such as large medical expenses
  
• Insurance policy provides more flexibility to
  handle special or changing needs while both
  participant and spouse are alive
  
• Borrow cash value or accelerate benefits

6
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• Disadvantages
• Life insurance option has costs and risks
• Pension maximization plan that is implemented
  some years before retirement will generally cost
  less than one that is implemented later
  
• Risk that the premium is not paid and the
  insurance will not be in force when it is needed
  
• What are the requirements?
• Compliance with the requirements of the
  Retirement Equity Act of 1984 (REA)
  
• Required spousal benefits
• Qualified pre-retirement survivor annuity
  (QSPA)
  
• Automatic election unless the participant and
  spouse have made a proper election otherwise
  

7
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Annuity starting date
• Key date for determining whether benefits are
  payable as a QPSA or a QJSA or another selected
  optional form of benefit payable under the plan
  
• Living participant on the annuity starting date
  must have benefits as a QJSA, unless the
  participant and spouse have made a qualifying
  election otherwise
• Surviving spouse of a participant who died before
  the annuity starting date must receive a QPSA
  unless election for another benefit was properly
  elected by both participant and spouse
  previously
• Annuity starting date Key date for purposes of
  determining whether benefits are payable as a
  QPSA or QJSA or another form of benefit payable
  under the plan

8
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Annuity starting date
• First day of the first period for which an amount
  is paid as an annuity or in any other form as a
  retirement benefit under the plan
  
• Usually it is the normal retirement age
• For participants who retire early
• Earliest date that benefits may begin for early
  retirement or the first date when benefits are
  payable after retirement if later.
  
• REA requirements apply generally to all qualified
  pension plans
  
• Plans include defined benefit plans, money
  purchase, target benefit and cash balance plans
  

9
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• REA requirements apply generally to all qualified
  pension plans (cont'd)
  
• Defined benefit plan
• Survivor annuity requirement applies only to
  benefits in which the participant was vested
  immediately before death
  
• Survivor annuity requirements also apply to
  nonforfeitable benefits payable under any defined
  contribution plan that is subject to the minimum
  funding standards of IRC section 412
• Exception for profit sharing and stock bonus
  plans and ESOPs - These plans must conform
  unless all of the following requirements are met
  
• Each participants vested benefit is payable on
  the death of the surviving spouse, or, if there
  is no spouse, to a designated beneficiary
  
• The participant has not elected to receive
  benefits in the form of a life annuity
  
• The qualified benefit plan is not the recipient
  of a direct plan-to-plan transfer of benefits
  from a defined benefit, money purchase, target
  benefit or cash balance pension plan

10
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Exception for profit sharing and stock bonus
  plans and ESOPs (cont'd)
  
• Benefits must be available to the surviving
  spouse within a reasonable time after the
  participants death
  
• Access within 90 days is considered reasonable
• If these requirements are met
• Participant does not need spouses consent to
  take living benefits in some form other than
  joint and survivor annuity
  
• Permitted options would include
• Term certain annuities
• Discretionary installments
• Lump sum distributions

11
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Exception for certain benefits Benefits not
  required to be paid as QPSA or QJSA if
  
• At the time of death or distribution the
  employee was vested only in employee
  contributions and the participant died, or
  distributions commenced prior to October 22nd,
  1986, or
• If the present value of the participants
  nonforfeitable benefit is 5,000 or less
  
• REA requirements do not apply to IRAs
• Qualified pre-retirement survivor annuity
  (QPSAs)
  
• A property right of the spouse, created by law
• Survivor benefit is an immediate annuity for the
  life of the participants spouse

12
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Qualified pre-retirement survivor annuity (QPSAs)
  (cont'd)
  
• Defined benefit plan
• Must permit surviving spouse to elect to receive
  payments under a QPSA no later than the month in
  which the participant would have reached the
  earliest retirement age
• The participant may elect an alternative form of
  benefit, but only with the spousal consent
  
• What form of benefit and who should be
  beneficiary in the event of the participant death
  prior to retirement is often overlooked.
  
• For example, if spouse has adequate pension
  benefits in the spouses own right, the
  participant may want to name a child, parent,
  charity or other persons as beneficiaries of the
  retirement benefits
• Participant may select a benefit other than the
  pre-retirement survivor annuity at any time after
  age 35 and change this election at anytime before
  retirement
• Electing out of the pre-retirement survivor
  annuity generally increases the benefit payable
  at retirement
  

13
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Qualified Joint and Survivor Annuity (QJSA)
• Spouses survivor benefit may not be less than
  50 and not more than 100
  
• If the plan offers two QJSAs that are
  actuarially equivalent, the plan must specify
  which is the QJSA
  
• The participant may elect the other equivalent
  QJSA without spousal consent
  
• An election to waive the normal form of joint and
  survivor benefit must be made during a 90 day
  period ending on the annuity starting date
  
• Spousal consent not effective unless
• Consent is in writing
• The election designates a beneficiary who may not
  be changed without spousal consent

14
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the requirements? (cont'd)
• Spousal consent not effective unless (cont'd)
• The election designates a form of benefit, which
  may not be changed without spousal consent
  
• The consent acknowledges the effect of such
  election on benefit rights and
  
• The consent is witnessed by a plan representative
  or a notary public
  
• How it is done an example

15
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• How it is done an example (cont'd)
• Example
• Spouse age 60.
• JS annuity is 24,000.
• Pension benefit indexed for inflation at 4.
• Assume a 5.5 after tax return
• Combined tax rate of 31
• Maximum COLA of 4
• Life expectancy of 24.2 years

16
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the tax implications?
• Income taxation is deferred until distributions
  are received
  
• Distributions from a qualified plan will
  generally be taxed in their entirety
  
• Unless the participant acquired some non-taxable
  basis in the plan
  
• Life insurance proceeds are generally paid
  income-tax free
  
• Planners will have to consider the difference in
  taxation of the benefits to determine the amount
  of insurance required
  
• Planners must recognize the amount available to
  pay premiums (if the participant elects a SL
  annuity rather than a JS annuity) must be
  adjusted for taxes

17
Pension Maximization
Chapter 27 Tools Techniques of Life Insurance
Planning

• What are the tax implications? (cont'd)
• The value of a survivor benefit from a qualified
  plan will be included in the taxable estate of
  the participant
  
• If spouse is named as beneficiary it qualifies
  for the marital exclusion
  
• If the participant retains any incidents of
  ownership in the life insurance policy, the death
  proceeds will be includible in his or her estate
  
• If the spouse is named as beneficiary, the
  proceeds will qualify for the marital exclusion
  
• If the participant creates an irrevocable life
  insurance trust, the death proceeds can escape
  inclusion in the estate