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Frequently Asked Questions.

answers to common questions

Retirement Plan Administration

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Divorce Pension Valuation

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General

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Retirement Plan Administration

Plan Design, Implementation & Termination

Do you require us to enter into a service provider contract?

We prefer to use a brief Administrative Services Agreement. Over the years, we have found it to be a good way for both parties to better understand the business relationship they are beginning. For that reason, it is more of a letter of understanding which we request both parties to sign. It addresses responsibilities, standards, and expectations.

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What is involved in installing the plan and enrolling the plan participants?

Once you have settled on one of our proposals, ask us for our installation package, available via e-mail. This is a series of documents falling into three sections: (1) questions about the plan, (2) questions about the employer, and (3) questions about the participating employees. We can begin preparing the legal documents at that point.

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Can I add a defined benefit pension plan when a current plan already exists with the same employer?

Maybe. Generally, careful attention needs to be paid when an employer funds both a defined contribution plan and a defined benefit plan during a tax year. What’s more, there can be limits on the benefits and funding. Nondiscrimination testing compliance also is important in such situations. For those reasons, it is best to share the current plan with us and to discuss the new objectives.

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Isn’t insurance inside a pension plan one of the reasons defined benefit plans fell out of favor years ago?

Yes, for plans oriented primarily to nonowner employees. However, so-called split funded plans have not wavered in their popularity among small family businesses and closely held corporations. This is because plans in those types of employers have been designed around the needs of the owners, themselves. For those reasons, insurance continues to be popular for meeting estate planning, buy-sell, and related needs.

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If I terminate my defined benefit plan, can I start another one?

Under certain limited circumstances, yes. However, the amount of benefits (and therefore tax deductions) under two or more defined benefit plans of the same employer are limited to the maximum allowed under a single plan. (You can’t “beat the system”.)  This is true whether the plans are maintained simultaneously or not. This is true whether the plans are traditional defined benefit, cash balance, or 412(e). Therefore, if the first plan has generated maximum accrued benefits, there is no reason for the employer to start a new one. This also is why we ask during our proposal process if the employer has maintained any retirement plans in the past. However, it may be advantageous to start a defined contribution type plan upon the termination of a defined benefit type plan.

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Plan Funding

I want to purchase the insurance policy on my life from the retirement plan, but I heard that is an action prohibited under ERISA.

Not so. Transactions of this nature are allowed under a Department of Labor prohibited transaction class exemption. What is required is for the effect on the plan to be revenue neutral. The amount paid by the participant to the plan for the policy should follow the safe harbor provisions. Meaning the “interpolated terminal reserve” or an equivalent algorithm devised by the IRS. In the early years of a policy, this can mean a higher purchase value than the cash surrender value of the contract. Additionally, from the standpoint of the Department of Labor, all participants must be treated consistently.

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Can I use a Flexible Premium Universal Life product to help fund my pension plan?

In a traditional defined benefit plan, this product type is possible. However, careful attention needs to be paid to the Incidental Test of the Internal Revenue Service, since UL is considered a term policy by the IRS for this purpose.

In a 412(e) plan, things are considerably different. When the details of ERISA were constructed back in the 1970s, UL had not yet been introduced. 412(e) funding must be calculated on the basis of level premiums, and are subject to decreasing premiums when excess interest or policy dividends are paid. Neither of those requirements would necessarily rule out Flexible Premium Universal Life, as long as the premiums were paid exactly as calculated by the third party administrator each year. However, most insurers choose not to offer their UL products for this market, presumably out of concern that actual funding could be at odds with the calculations of the administrator. Instead, Interest Sensitive Whole Life and traditional Whole Life are today’s products of choice.

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What happens when the insurance is issued differently than shown in the proposal?

This can happen due to a change in risk class during the underwriting process. For example, when the employee we thought was a nonsmoker turns out to be a smoker, or when the policy is rated. In these cases, a different amount of insurance is purchased by the designed premium. However, it is important to let us know when this occurs, since a different amount of coverage also can mean a different amount of insurance cash value. In turn, that means that the non-insurance funding also must change from what was proposed. Hence, it is important for us to refine our calculations whenever a policy is issued differently from what we assumed in our proposal.

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412(e)(3) Plan Specific

The low rate of return on 412(e) plans seems unattractive.

To the contrary, this is the feature that makes them popular. A low rate means a high funding target, since they move in opposite directions. In turn, a high funding target requires high annual funding (and deduction). For businesses and/or individuals with high marginal tax rates, this can mean significant tax deferral. Hence, astute small business owners often are more than willing to accept low interest rates in combination with high tax relief. Instead of gains coming from uncertain market returns, they come from more certain tax relief.

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I’ve heard people say that 412(e) plans are likely to be a fad, like many tax-motivated “schemes”.

Time will tell, although 412(e) and its predecessor 412(i) have been part of ERISA since its inception in 1974. For that reason alone, it should not be called a fad. Those questioning its long term viability may be referring to a few practitioners who took aggressive positions with insurance funding years ago.  In turn, that triggered a “shut down” of those overly aggressive practitioners by the Internal Revenue Service. However, keep in mind that most plans are designed conventionally, and for that reason the future prospects for the 412(e) market continue to be bright. It is important to match the right solution with the right problem. 412(e) plans are best used for addressing a narrow but deep set of circumstances, meaning that they are not suitable for everyone. However, when they fit, they can produce excellent results. We look forward to the market continuing to develop on those terms.

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Our Services

Is there a charge for your proposals (feasibility studies)?

Although some third party administrators charge for proposals, we do not at this time.

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Who pays your administrative fees? When are they due?

The employer pays our administrative fees. First, a one-time set-up fee is due at the time the plan is installed. Secondly, there is an annual charge which we invoice at the end of each plan year (including the first year). We are not compensated by product commissions or by assets under management.

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Our Experience

What size pension plans do you administer?

Presently we specialize in defined benefit pension plans with participation ranging from 1 to 20 individuals. Usually that means a small employer. However, occasionally it can mean a very large employer with a small number of employees eligible for the plan.

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Do you have experience with plans in Controlled Group employers?

Yes. We also have broken down cost figures by adopting company, when requested. We also have experience in advising companies on mergers and acquisitions when new subsidiaries are added to the controlled group. The same is true with Affiliated Service Groups and groups under common control.

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Do you have experience with Collectively Bargained pension plans?

Yes, both in designing and in administering them. However, the vast majority of our present clients are not collectively bargained.

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Divorce Pension Valuation

Calculations & Methodology

Is the split in pension value (marital vs. non-marital) required to be based on elapsed time?

In Minnesota, yes, according to the famous 1983 case, Janssen v. Janssen. In it, the Minnesota Supreme Court held in part that “all property acquired by either spouse subsequent to the marriage and before a decree of legal separation is presumed to be marital property regardless of whether title is held individually or by the spouses in a form of co-ownership such as joint tenancy, tenancy in common, tenancy by the entirety, or community property.” Also refer to 2013 Minnesota Statutes, §518.58.

While this method is popular in other states as well, the requirements of a particular jurisdiction may be different from that used in Minnesota.

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Why is the full benefit used in the calculation and not just the vested portion of the benefit?

This also comes from the 1983 Minnesota Supreme Court case, Janssen v. Janssen. There, the Court based its conclusion on “principles of promissory estoppel” and rejected the alternate “gratuity approach”. It held that a pension is a “contractual right: a property interest”, but warned that different conclusions could be reached between community property states and common law states.

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How do you take into consideration the plan’s mortality factors?

We don’t. The plan uses mortality factors for a variety of reasons, including funding adequacy, tax deductions, and trend analysis. In many cases they are influenced by the requirements of various statues. None is valid for determining the present value (lump sum) value of the benefits of an ex-employee once the payments leave the plan. Mortality tables used to administer the plan tend to be based on demographics determined from group data. In contrast, those used in divorce calculations tend to be based on demographics based on individual data.

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How do you determine life expectancy?

We don’t. A common misunderstanding is that monthly pension payments ending at life expectancy is the basis for the calculation. Instead, an actuarial valuation is based on discount rates and probabilities of survival to the end of the mortality table. Those commonly used for divorce valuations include probabilities of survival to age 115, or even older. Although the chance of living that old is quite small, each piece of probability influences the final outcome. Life expectancy is a convenient approach for nonactuaries, since it assumes everyone lives exactly to their life expectancy. However, life expectancy means the age at which the average person dies among a large population. That is, half the population dies before that age, and the other half dies after that age. But using life expectancy for everyone ignores the basic probabilities of survival. So, while a life expectancy-based calculation might give a ballpark answer, it is not an actuarial calculation.

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How do you take into consideration the plan’s own rate of return on its investments?

We take into account actuarial equivalent factors published by the plan when calculating the monthly benefit receivable by the ex-employee. However, that is where it ends, and in particular the return on plan investment is not used in our calculation.

It is a common misconception that the single sum value of benefits is calculated based on the investment return experienced internally by the plan. Instead, we determine a risk-free discount rate outside the plan. The stream of monthly pension payments is received by the retiree outside the plan. This means that gains or losses inside the plan have no impact on the external value of the payments outside the plan.

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Our Services

What information do you need to start the calculations?

Basically, information about the parties to the divorce and the pension benefit, itself. Refer to our Practice Areas page, where the specifics are outlined in four categories:

  • General Information
  • Monthly Pension Amount
  • Summary Plan Descriptions
  • Material From Opposing Counsel

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