Legislative Changes and the Impacts on Non-qualified Plans and the Use of COLI as a Funding Vehicle

THE PENSION PROTECTION ACT 2006 & AMERICAN JOBS CREATION ACT 2004

 

BACKGROUND

For the past several years companies have dealt with uncertainty regarding the potential impacts of new legislation that would affect how non-qualified benefit plans are administered. Additional changes to how companies can use corporate owned life insurance (COLI), which is often used to fund certain corporate liabilities, have added to the confusion. As a result many companies have decided to do nothing. They have chosen not to implement new plans, modify existing plans or examine their funding until there was clarification. Fortunately, the confusion surrounding these issues has been clarified and companies can examine their plans with the full knowledge and understanding of what will be required.

The two new regulations are the American Jobs Creation Act of 2004 (AJCA) and the Pension Protection Act of 2006 (PPA). The AJCA created a new section of Tax code 409A that limits specific provisions in non-qualified retirement plans. The PPA impacts how companies can utilize life insurance in the funding of their benefit plans. The specifics of these two laws may be found in the Appendix to this article. What is more significant than the specific do’s and don’ts is the fact that companies now have specific codified regulations regarding the administration and funding of their non-qualified benefit plans.  The new regulations allow companies to proceed with implementing or modifying their plans with the knowledge and guidance of the government defined provisions. The regulations provide companies with an opportunity to re-examine their plans and funding and take steps to ensure that they are in full compliance of these rules.

CONCLUSION

As a result of these legislative changes, companies now have specific direction under the law to administer their non-qualified plans as well as to use life insurance as a funding mechanism. Questions existed prior to this regarding what features and benefits were acceptable and allowable, how much insurance could companies use and how the plans should be structured. The lifting of this veil of uncertainty provides a tremendous opportunity for companies to establish or modify their plans according to the law. Just as the pension legislation of the 1980’s and 1990’s provided greater specificity for the management of companies’ 401(k) plans, the new rules and regulations give companies a set list of rules to follow for their non-qualified plans and the funding of those plans.  This could not be better news for companies as much of the gray areas of administration and funding have been eliminated.  Furthermore, the guidance provided by these laws can be easily implemented and followed.

For tax paying companies, the benefit of using life insurance is substantial; as a result they should review their existing funding to ensure compliance with the new regulations, as well as making sure the products are the most efficient available today. Doing so will result in retirement plans which provide excellent benefits for participants, substantial cost savings for the company and protection under the law.  

APPENDIX

American Jobs Creation Act of 2004

The AJCA legislation impacts non-qualified plans. The law was signed on October 22, 2004 and puts a new section of the tax code, 409A, in place. 409A impacts all deferred compensation plans and deferrals made in 2005 or later.

The key provisions of Section 409A:

o        The “Haircut” provision, which allows participants to take their money out early with a deduction of some type (often 10%), is no longer permitted.

o        The acceleration of retirement distribution elections will no longer be permitted.

o        Distributions to “key employees” must be made six months from the date of termination or retirement.

o        The re-deferral of In-Service Distribution elections are permitted but must be received at a minimum of five years from the date of the original distribution election.

o        Disabled Participants can elect to begin receiving retirement payments or continue to defer.

o        The legislation allows companies to “grandfather” their existing deferred compensation plan (deferrals through 2004).  All deferrals made after December 31, 2004, would not be eligible to become “grandfathered” and would therefore be subject to 409A legislation.

o        Any change to an existing plan that is deemed a material modification will subject all deferrals (both pre- and post-2005 deferrals) to the new regulations.

Failure to comply with these regulations will mean the immediate taxation of all balances to the participants of the plans.

Pension Protection Act of 2006

The Pension Protection Act of 2006 was enacted on August 17, 2006. While most of the press has focused on the impacts to qualified plans, especially defined benefit plans, significant changes were made to how companies may utilize life insurance in the funding of their liabilities. Within this law is a section that has been referred to as “COLI Best Practices”. This new legislation codifies some specific requirements for companies that utilize COLI. Specifically:

·          Only the top 35% of employees by compensation may be insured.

·          Employees must be informed that the company intends to insure their lives and the amount of insurance that will be in place at the time the policy is issued. Employees must sign a consent allowing the employer to purchase the insurance on their life.

·          The company must report to the IRS the following items:

o        The number of employees at year end, and

o        The number of employees insured under the COLI policies, and

o        The total amount of COLI in force, and

o        The employer’s name, address and type of business, and

o        Confirmation that the employer has a valid consent from each insured employee (or the number of insured employees for whom insurance was not obtained).

Failure to comply with these regulations will result in the taxability of any death benefits received by the company. 

This piece is intended to provide authoritative information on the subject covered and is not a solicitation. It is not intended to provide specific legal or tax advice.