Bay
Financial Newsletter:
Death-Benefit-Only
Plans – 2004
Whether you are an employer or an employee – or who have a friend
or relative who is either - a D.B.O. plan may be of interest.
A Death-Benefit-Only (DBO) (sometimes called a Survivors Income Benefit)
plan is a legally binding agreement between an employer and one or
more key employees.
It’s called a “Death-Benefit-Only” or “Survivors Income Benefit” plan
because no living benefits (such as disability or retirement benefits)
of any kind are provided for the employee under the plan. The plan
provides, as it’s name implies, only death benefits and pays only
if the selected employee dies while employed by the employer prior
to a specified retirement date, and only if survived by a spouse or
a beneficiary in a class designated by the employer.
The employer agrees that if the selected employee dies before retirement,
it will pay a specified amount (or an amount determined by formula)
to the employee's spouse, if living, or to another employer-designated
class of beneficiary (such as children or dependent parents).
Sometimes the amount payable at the selected employee’s death is a
multiple of salary. An example would be a plan that promises to pay
three (to five) times the employee’s average base pay in the three
years preceding death. More commonly, the death benefit is expressed
as a fixed amount such as $50,000 or $100,000 a year for a specified
number of years (often three, five, or ten years).
A DBO plan can be used to provide literally hundreds of thousands
of dollars of income to the family of an executive or other employee
and – if the plan is arranged properly – every one of those dollars
can be federal estate tax-free under current law. This potential for
avoiding federal and state tax on massive amounts of income to survivors
of selected employees extends to any employee – including stockholder-employees,
as long as they own 50 percent or less of the corporation’s stock.
A DBO plan is one tool that should certainly be considered – apart
from the incredible estate tax advantages – when additional income
is desired for the survivors of any employee. This is an incredible
way to attract and retain key employees.
The DBO plan is particularly cost effective because if a covered key
employee terminates employment, the corporation can keep the policy
in force by continuing to pay premiums, place the policy on extended
term or reduced paid-up status, cash it in, or sell it to the employee.
There are no specific IRS restrictions or limitations that must be
followed. So an employer is completely free to choose (a) who will
be covered by a DBO plan, (b) the terms of the plan, and (c) the benefit
levels. Note that an employer can also vary these terms and benefit
levels among covered individuals and, therefore, can have different
DBO plans for different key employees. This makes the DBO plan an
excellent “selective executive” fringe benefit.
From the employee’s viewpoint, a DBO plan provides a large amount
of life insurance protection without any current cost. Under a split-dollar
arrangement, the costs for current term life insurance increase rapidly
after the insured reaches age 50, while there is no comparable yearly
term cost or reportable income with a DBO plan.
A DBO plan can be very flexible. At the employer’s sole discretion,
the plan can be “converted” to a nonqualified deferred compensation
plan when the covered employee retires. In other words, the employer
can arbitrarily choose to use some or all of the values in the underlying
financing mechanism to turn a death-benefit-only plan into a nonqualified
supplement retirement plan. This gives the employer a strong set of
“golden handcuffs” to tie a young (or new) and potentially valuable
employee to the firm and encourage that person to remain with the
firm.
Changes in qualified plan rules, harsh and complex distribution rules,
final split-dollar regulations and the ever increasing taxation under
current environment have made these benefit plans – although viable
and in many cases appropriate planning tools – nevertheless more costly
and difficult to administer.
Taken as a whole, all of these factors enhance the appeal of the already
impressive DBO plans as alternatives or supplemental benefits to attract,
reward and retain key employees. As such, DBOs should be considered
when designing a comprehensive executive benefit package.
AS ALWAYS, PLEASE FEEL FREE TO CALL
TO DISCUSS THIS OR OTHER ISSUES OF IMPORTANCE TO YOU,
YOUR FAMILY, OR BUSINESS.
