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October 24
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www.companionlife.com
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Tax Facts................................. 19
800.543.0874
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Prudential
schedules that vest every three to five years. At vesting, income
tax is paid from the account value, and the after-tax amount is left
in the plan. The advantage: Earnings on the after-tax balance can
continue to grow tax-deferred until retirement. Thereafter, the
plan balance can be rolled into an individual retirement account.
Stockwell says this technique may be widely adopted in com-ing years if, as he expects, the IRS issues by year-end guidance
(as per IRS Notice 2007-62) extending to all 457 plans a more
restrictive definition of substantial risk of forfeiture. Applicable
to non-qualified deferred comp plans governed by IRC Section
409A—a body of law from which 457(f) plans have been exempted if structured as short-term deferrals—the more narrow definition would no longer permit 457(f) plan participants to create a
substantial risk of forfeiture using a non-compete agreement or
other promise to refrain from performance of services.
Still to be clarified by the IRS, sources add, is the method by
which plan benefits are to be valued for tax purposes. Absent a
substantial risk of forfeiture, the tax is based on the present value
of the benefit. But Sirkin says the rules are vague as to which
interest rate may be used in the present value calculation. Also
unclear is the impact on present value of a benefit that “
disappears” before the executive retires.
“Given the lack of clarity, we try to avoid plan designs that
call for a disappearing benefit,” says Sirkin. “Other advisors use
the technique, but have taken the position that the benefit is not
taxable because it disappears.”
He adds that small tax-exempt organizations with limited
resources tend to structure 457(f) plans as defined contribu-
tion plans, though some use a target benefit formula to emulate
defined benefit plans. Larger organizations that can fund a
traditional DB plan represent key prospects for life insurance
professionals.
Why so? These organizations, market-watchers say, look to
life insurance to recover the cost of the benefit. The executive
benefit, informally funded with an employer-owned life insurance policy, can be paid from the contract’s accumulated cash
value at retirement. At the executive’s death, the income tax-free
death benefit is paid to the employer, thereby reimbursing the
employer for the cost of the premiums.
But sources note that life insurance is generally not used to
fund 457(b) plans. The reason: Absent a cost-recovery objective,
which isn’t present when the deferrals are paid for only with employee contributions, the tax-favored treatment of life insurance
is of no benefit to tax-exempt organizations. Observers point out,
too, that, most non-profits don’t buy key person insurance, which
can be used to cover losses stemming the death of a key exec.
With or without life insurance, market-watchers say, 457
plans can be challenging to design, implement and service without running afoul of IRS tax law provisions. Hence the value of
partnering with a competent plan administrator; and, when the
advisor is lacking in the requisite expertise, finding a professional
who has it.
“If you’re not well versed in the plans’ technical requirements,
the best advice I can give is to team up someone who is,” says
Sirkin. “It’s very easy to trip up when executing these plans.” NU
