All posts in Retirement Planning

08 Apr

Use Life Insurance and a Rabbi Trust To “Fund” Your Nonqualified Deferred Compensation Plan

Estate Planner Mar-Apr 1998

Companies use nonqualified deferred compensation plans to compensate key employees over and above the employees’ base salaries. Because employers cannot set aside money protected from creditors to fund nonqualified plans without incurring current tax liability for the employees, they often use life insurance and rabbi trusts as funding mechanisms to meet both the employees’ needs and their own.

How Nonqualified Plans Benefit Employers 

Nonqualified plans benefit employers by offering the employees an incentive to stay with the company over a period of years, often through a vesting mechanism. For example, a plan might provide that an employee will receive a certain amount of compensation on termination of employment, but that only a portion of that compensation will vest each year over the next 10 years. Thus, to receive the entire amount of deferred compensation, the employee must remain with the company for 10 years.

In addition, with a properly structured nonqualified plan, the company can avoid the highly complex and burdensome rules that cover qualified plans. These include rules on participation, coverage, discrimination and reporting.

How Nonqualified Plans Benefit Employees 

Nonqualified plans benefit key employees by allowing them to defer tax on compensation that they will receive in later years, when their effective tax rate may be lower. Under a typical nonqualified plan, amounts are deferred while the employee works for the company and are paid later when the employee retires, becomes disabled or dies. The goal is to structure the plan so that the employee is not taxed on those amounts until one of these events occurs and the employee is actually paid.

To ensure that the employee is not subject to current tax on the amounts payable under the nonqualified plan, the plan cannot be funded. This does not mean that a company cannot set aside funds to satisfy its future obligations. What it does mean is that any amounts a company sets aside to ultimately pay the deferred compensation must be subject to the claims of the company’s general creditors. Otherwise, the employee is treated as having received the compensation and is currently taxed on those amounts.

Life Insurance Provides Indirect Funding Mechanism

Life insurance is a popular funding mechanism for a nonqualified plan. Typically, an employer purchases insurance on the life of an employee. The company then owns the policy and also is named its beneficiary, but does not receive a deduction for premium payments on the policy. To avoid being taxed on the value of the contract, the employee generally does not receive any interest in the policy. The employee cannot name a beneficiary to receive life insurance proceeds on his or her death, but can name a beneficiary of the nonqualified plan, such as his or her spouse, to receive the then-vested amounts of deferred compensation.

Any insurance proceeds paid to a company on an employee’s death generally are on an income-tax-free basis, though they may be subject to alternative minimum tax. If the employee retires or becomes disabled and is entitled to amounts under the nonqualified plan, the company can relinquish the policy and use the cash value to pay the deferred compensation. This may, however, result in current taxable income to the company, but only to the extent of the gain.

The Rabbi Trust Offers Preservation and Protection

A rabbi trust is a type of nonqualified plan in which funds are segregated into an irrevocable trust. The trust helps preserve funds an employer might otherwise spend and offers an employee some measure of comfort that money will be available when the deferred amounts become payable to him or her.

More important from an employee’s perspective, a rabbi trust allows a company to irrevocably segregate funds that it can use to pay the compensation in the future. Although these funds are subject to the claims of the company’s general creditors, they remain in the trustee’s control if the company changes hands. Despite the fact that funds are segregated, the rabbi trust is not deemed to be a funded plan.

Life Insurance and Rabbi Trust in Tandem

A company can use life insurance in tandem with a rabbi trust by making contributions to the trust to fund the premiums. The trust then uses those funds to purchase insurance on the employee’s life. The trustee is both the owner and beneficiary of the policy.

To avoid current taxation, neither the employee nor his or her beneficiary can have an interest in the insurance or the trust assets. The employee (or his or her beneficiary) will only have rights to amounts held by the trust equal to those of an unsecured creditor. If the nonqualified plan meets these and certain other requirements, it will be considered unsecured and unfunded, and income tax to the employee will be deferred.

Benefits for Employer and Employee Alike

A nonqualified plan can effectively help an employer secure the continued services of a key employee. By purchasing life insurance through a rabbi trust, the company can enjoy a tax-advantaged investment vehicle while giving the employee some peace of mind that funds will be available to pay the deferred compensation. To learn more about these options, please call us. We can help you choose one that meets your needs.


Insurance Benefits for Companies With Nonqualified Plans

Used to fund a nonqualified plan, life insurance provides several benefits:

  • A company can receive a market rate of return on the investment in the policy while using it as a tax-deferred investment vehicle.
  • If an insured employee dies early in the term of the nonqualified plan, funds will be available to the company through the payment of the death benefit, which the company can then use to pay the employee’s beneficiary under the plan.
  • With a combination of loans and withdrawals against its cash value, the company can achieve tax-free distributions from the policy.
08 Apr

Making the Right Senior Housing Choice

In Retirement Planning,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 2000

You’ve probably heard of seniors having trouble with living alone and the related financial burdens. But what happens when it is you, your spouse or your parent? What options exist for an aging person, and what do they mean financially? Now more than ever, estate planning that takes elder care arrangements into consideration is essential.

Elder care is a booming business. New living arrangements for the elderly are still developing. Children of aging parents are looking for alternatives to traditional nursing homes. The most popular new option is assisted-living facilities.

Surveying the Options

Assisted-living facilities provide each resident with a room or suite, meals (sometimes in a common dining room) and a 24-hour staff who assist with daily routines, such as bathing, dressing and taking medication. Assisted living is best suited to seniors who are cognitively impaired yet physically capable or who are mentally capable but have motor or balance difficulties. Residents can retain some degree of independence and privacy while receiving needed care. The price for an assisted living unit averages $2,000 per month (higher in some geographic areas) varying based on amount and type of services provided and unit size.

Nursing home facilities are best suited for seniors with significant medical problems or memory impairment. They are also appropriate for those who have problems that their caregivers can no longer manage such as wandering, agitation or erratic behavior. A nursing home generally provides 24-hour professional nursing care, physical therapy and recreational therapy. A nursing home can cost anywhere from $1,500 to $5,000 per month or more, plus extras.

How To Choose a Facility 

When investigating a facility, ask if you can walk through the common areas and talk with some of the residents. Find out the ratio of caregivers to residents. Try to gauge whether the staff is caring and friendly. Ask residents and their visitors how responsive the staff is and how well they interact with residents. Although generally not indicative of the quality of care, a pleasing and warm decor may make seniors feel more at home. A registered dietitian may be advantageous for seniors with special dietary needs.

Also consider these questions: Is the facility conveniently located? Does it offer religious services or transportation to services? If the facility is in an urban area, does it offer special outings for residents? What reputation does the facility have in the surrounding community?

Nursing homes are regulated at both state and federal levels, while assisted-living communities are overseen just at the state level. This may result in differing standards. Carefully examine the guidelines for each type of facility. Understanding the regulations governing these types of facilities and knowing whether they are in compliance helps you determine the quality of care. Contact the health department’s senior or elder unit in the county or state where the home is located to determine if the home has a reputation for complying with regulations.

Beware of Pitfalls 

The rapid growth of the assisted-living industry has resulted in some problems. A recent survey conducted in four states found “unclear or potentially misleading language” in sales brochures for approximately one-third of the 60 assisted-living facilities surveyed. One common concern was the lack of clear guidance regarding under what circumstances a resident may be expelled. These types of facilities, as with nursing homes, are driven by supply and demand and should be looked into carefully.

How To Pay for It 

One way to manage the cost of nursing home care without forfeiting all your assets is to purchase long term care insurance, which can defray or pay the cost of nursing home care. The cost of long term care insurance depends on the age of the insured at the time coverage is purchased. For example, a long term care policy purchased at age 55 may cost $800 per year, while a policy offering the same benefits bought at age 65 may cost twice as much. As long as the cost is not prohibitive, a policy can be a worthwhile investment and an important part of the estate planning process. Be certain that the policy purchased covers all levels of custodial and skilled nursing care and builds in adjustments for inflation.

Medicaid may pay for a portion of nursing home costs if the senior meets the eligibility criteria. Be sure to verify that a nursing home takes Medicaid patients. In general, most of the individual’s assets must be depleted before Medicaid will cover the cost of nursing home care. But a nursing home patient’s spouse may retain a residence along with other minimal assets.

Because assisted-living communities are not medical facilities, Medicare and Medicaid will usually not cover their costs. But some states do permit the limited use of Medicaid funds for assisted living.

Let Us Help

Estate planning is more than protecting and preserving your assets for your family. It also encompasses planning for loved ones’ care, comfort and security as well as your own. Please contact us if we can be of assistance in evaluating the sometimes confusing housing options available for seniors.

08 Apr

Are Your Retirement Benefits Safe From Creditors?

In Retirement Planning,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner Nov-Dec 2000

Maintaining a qualified retirement plan, such as a 401(k), offers long-term security. But how safe are these assets if you are subject to claims before retirement? The Internal Revenue Code specifically bars qualified plan benefits from being assigned or alienated except under certain circumstances. The U.S. Supreme Court has taken this further, conclusively holding that ERISA qualified plan benefits are absolutely protected from creditors, including in bankruptcy, other than the IRS, spouses and ex-spouses under qualified domestic relations orders. Nonetheless, several questions come to mind.

Are IRAs Protected? 

Upon retirement, retirees commonly roll over 401(k) and other qualified plan assets into individual retirement accounts (IRAs). But the protection for assets held in such nonqualified plans is unclear. Federal law does not expressly protect them, although many states have enacted statutes that do.

Are Distributions Protected? 

Whether a plan distribution is protected from creditors primarily depends on state law, and, as with IRAs, the protection afforded varies widely. Many states give some level of protection to funds that are segregated and consist only of the amount necessary for the support of the debtor.

Other states rely on federal law. Federal bankruptcy exemptions apply to distributions reasonably needed for the support of a plan beneficiary. But it is unclear whether the debtor must already be receiving payments to take advantage of the exemption. Clearly unprotected are amounts in excess of what is reasonably necessary for support.
Unfortunately, federal law mandates when distributions must begin and how much must be taken. If creditors are an issue, hold off taking distributions as long as possible.

Are Funds Contributed Shortly Before Filing Bankruptcy Protected? 

The fraudulent conveyance rules bar giving assets away to avoid paying a creditor. Conversion of assets that are not protected into assets that are, such as contributing funds to a 401(k) shortly before filing bankruptcy, should not, strictly speaking, be a fraudulent conveyance.

But a prefiling contribution doesn’t look good, particularly if the timing of the contribution is unusual for the debtor. A bankruptcy trustee can refuse a discharge order for a debtor who has engaged in transactions that appear to impede a creditor’s rights.

Smart and Effective

Maximizing contributions to plans continues to be one of the most effective retirement savings and asset protection devices available. Despite uncertainties, the potential benefit appears to outweigh the risk. If you have any questions about the security of your plan please call us. We would be glad to help you assess your accounts and advise you on ways to scrutinize the risk of loss to creditors.