Alternatives to 401(k) Plans for Highly Compensated Employees (HCEs)

Almost all 401(k) plans discriminate heavily against HCEs and encounter qualification problems when the required anti-discrimination testing rules are applied. The typical solutions to solving these problems are both unfavorable and costly. Two interesting alternatives for HCEs are available for solving these problems more effectively, both involving the sale of life insurance: (1) Non-Qualified Deferred Compensation Plans (using COLI) and (2) A special proprietary "LBP 401(k) Plus" Plan (using individual non-variable policies).

In connection with Non-Qualified Deferred Compensation Plans, an effective approach that leads the client to choose COLI financing rather than having to be sold COLI is the consultative approach that presents the financial results of all approaches, from no financing (using current cash flow) to financing with mutual funds or other instruments; COLI then typically "sells itself".

Buy-Sell Agreements

We are all intimately familiar with the need for buy-sell agreements when dealing with closely-held private business interests, but how often are we aware of the typical problems and shortcomings encountered with most agreements? There are three important things to remember here: (1) Getting Agreement NOW when everyone’s interests are reasonably comparable; (2) Paying attention to the Six Defining Elements of a proper agreement (Standard of Value, Level of Value, the "As Of" Date, Qualification of Appraisers, Appraisal Standards, and Funding Mechanisms); and (3) Periodically applying a Buy-Sell Audit Checklist.

One of the key factors requiring particular attention here is the valuation methodology being employed. An interesting idea to suggest is the "1% Solution": having the parties devote 1% of the business value annually to hiring the expertise necessary to make sure that all aspects of the agreement are still relevant, up-to-date, and accomplishing the desired results.

21^st Century Estate Planning Is Like a Three-Legged Stool

The three legs are: (1) Zeroing Out Estate Taxes; (2) Perpetuating Family Values and Relationships; and (3) Charitable Planning (we call this "Planned Philanthropy").

Zeroing Out Estate Taxes: There are a multitude of planning tools that can be used to accomplish this result, all of which require the services of highly qualified advisors (you, of course, plus a highly qualified estate planning attorney and other high-level advisors). An interesting idea to implement when FLPs and/or LLCs are part of the planning package (both of these can be excellent asset protection vehicles when used creatively), involves the use of special planning techniques that call for first-to-Die (i.e., single life) policies rather than the usual approach that favors 2^ND-to-Die policies; the details of this idea are highly technical and complex and beyond the scope of this summary.

Perpetuating Family Values and Relationships: Since most inherited wealth disappears in two to three generations, often because the parents inadvertently fail to pass along their work ethic and family values, "Heir Conditioning" becomes an important component of effective estate planning. Family counseling has thus become common with wealthy families, and multi-generational trusts have become an extremely valuable planning tool for providing asset protection and protection against divorcing spouses, and for avoiding estate taxes in succeeding generations.

Charitable Planning ("Planned Philanthropy"). Most of us are at least somewhat familiar with the variety of tools that can be used here — Charitable Remainder Trusts, Pooled Income Funds, Charitable Gift Annuities, Charitable Lead Trusts (both Inter Vivos and Testamentary), Charitable Bailout Trusts, Family Charitable Foundations — not many of us are very effective in motivating our clients to incorporate these techniques into their estate plans. Perhaps by emphasizing Voluntary Philanthropy vs. the Involuntary Philanthropy automatically involved when paying estate taxes, and by performing appropriate financial modeling, we can overcome this shortcoming.

By the way, the seat of our three-legged stool is made up of the legal documents, accounting practices, and life insurance funding that holds it all in place.

Overall the new rates represent an average decrease of 3 percent - and that is significant in the term business! 

AIG has made significant decreases in some of the most common term periods and ages, but the most significant changes are in the double-digit decreases for 40-year-olds.

Check out the situations below where AIG’s lower rates have made a dramatic difference!

Male, Pref. NT, Age 40, $500,000 Face, 20-Year Plan:

The annual premium under Select-a-Term 2007 was $565.00. Under Select-a-Term 2008, the new premium will be $475.00 - a reduction of 15.9 percent!

Male, Pref. Plus, Age 40, $500,000 Face, 20-Year Plan:

The annual premium under Select-a-Term 2007 was $450.00. Under Select-a-Term 2008, the new premium will be $380.00 - a reduction of 15.6 percent!

Male, Pref. Plus, Age 40, $1,500,000 Face, 15-Year Plan:

The annual premium under Select-a-Term 2007 was $815.00. Under Select-a-Term 2008, the new premium will be $665.00 - a reduction of 18.4 percent!

Male, Pref. Plus, Age 40, $1,500,000 Face, 20-Year Plan:

The annual premium under Select-a-Term 2007 was $1,175.00. Under Select-a-Term 2008, the new premium will be $980.00 - a reduction of 16.6 percent!

Prudential’s repricing will make their term products more competitive in many key scenarios, such as:

Large Face Amounts - policies with face amount larger than $1 million;

15, 20, and 30-year level paying periods - will all see pricing improvements.

Transition Period Rules

There will be no preview period - normal 28-day Transition Period Rules apply. Unplaced cases may be eligible for new rates, subject to eligibility rules.

Age Last Birthday Advantage

And don’t forget Prudential’s Age Last Birthday advantage! Why should your clients be older than they actually are? With Prudential your clients are always their actual age, not age nearest.

If your clients are looking for a Term product - Think Prudential!

Irrevocable Life Insurance Trusts, and especially Intentionally Defective Grantor Trusts, are almost always the best way to go when life insurance (both single life and 2^nd-to-Die) is being purchased to pay estate taxes.

However, very few trusts that I’ve seen, even those prepared by high-powered (and priced) estate planning attorneys are really well-drawn to accomplish the desired purposes without potentially serious problems somewhere along the line.  This makes it extremely important to at least try to get a copy of an existing trust ASAP if there is one, or to see a draft of a new trust before it is executed.

But that’s just the beginning, in 2 cases in the last 2 days, I have experienced problems with the way money gets into a trust and then to the insurance company, so I thought it would be a good idea to set forth the proper procedure:

1. Whoever is making gifts to the trust (or more properly stated, to the beneficiaries of the trust via the trust) should make their check payable to the trustees of the trust, “as trustees”, not as individuals.

2. The trustees should have their own bank account as trustees and should deposit the check into that account.

3. The trustees should then make out their own trustee check for the amount of the premium payable to the insurance company.

It used to be that this procedure could be shortened and simplified by having the trustees endorse over to the insurance company the check they receive from the donor(s), but at least one carrier (AXAEquitable) now considers that to be a third-party check and will not generally accept it (I was able to get an exception in our case, but I wouldn’t count on that happening again).

The key here is to establish a CLEAN PAPER TRAIL.

Please do not conclude that this is all that needs to be done when dealing with ILITs, because there are other required procedures that need to be followed under the “Crummey” withdrawal rules in order to qualify gifts for the gift tax annual exclusion.

        Bob