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Washington Report
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The Washington The AALU AALU Washington Report is published by Report is published by AALUniversity, a AALUniversity, a knowledge serviceofofthe the knowledge service AALU. The AALU. The trusted trustedsource source of actionable actionable technical of technicaland and marketplace knowledge forfor marketplace knowledge AALU members—the members—the nation’ AALU na- s most advanced life insurance tion’s most advanced life professionals. insurance professionals. The AALU Washington
The AALU Washington Report is prepared by the Report is prepared by the AALU staff and Greenberg AALU staff and Greenberg Traurig, one of the nation’s leading law in tax ands Traurig, onefirms of the nation’ wealth management. leading law firms in tax and wealth management. Greenberg Traurig LLP Jonathan M. Forster Greenberg Traurig LLP Martin Kalb Jonathan M. Forster Richard A. Sirus Martin StevenKalb B. Lapidus Richard Sirus RebeccaA. Manicone
Steven B. Lapidus Rebecca Manicone Counsel Emeritus
Gerald H. Sherman 1932-2012 Stuart Lewis 1945-2012 Counsel Emeritus Gerald H. Sherman 1932-2012 Stuart Lewis 1945-2012
Washington Report 13-37 Life Insurance – Selecting the Best Topic: Funding Trust-Owned Option.
Topic: “Top-Hat Plan” Exemption Compliance for Deferred Compensation Arrangements MARKET TREND: Although a higher federal estate tax exemption means fewer families will face federal estate tax exposure, the use of trusts in life insurance
MARKET TREND: As key executives continue seek options plans will continue to serve numerous practical and taxtoplanning needs.for deferring the receipt and taxation of current income, there likely will be a corresponding increase in inquiries employers as how to structure nonqualified SYNOPSIS: Planningfrom with trust-owned lifetoinsurance (“TOLI”) must consider deferred compensation plans to meet the “top-hat plan” exemption the funding of premiums into the trust. Numerous funding methods exist,from many ERISA requirements. including: (1) annual exclusion gifts, (2) lump-sum gifts of gift and GST tax exemption, (3) split-dollar arrangements, (4) installment sales to ILITs or (5)
SYNOPSIS: Nonqualified deferred plans generally are a combination thereof, with each methodcompensation varying in terms of administrative considered pension plans within the meaning of ERISA and are subject to complexity and tax-efficiency. rules regarding plan design and administration, including funding, vesting and fiduciary duties. rules,for however, apply toprotection an unfunded plan TAKE AWAYS: TOLI These is beneficial creditor do andnot beneficiary maintained by an employer primarily fortax the purposeand of income providing purposes, wealth management, state estate planning, tax deferred compensation for a select group of management or highly compensated planning. The selection of the best premium funding method will depend on each employees (i.e., acircumstances “top-hat” plan). there no clear-cut guidance family’s particular and While goals, and theislevel of on-going support defining what constitutes “select group of management or highly compensated they will have fromatheir insurance, tax, and legal advisors (including policy and employees” for purposes a top-hat plan,or several cases have funding reviews). Generally,ofannual exclusion lump sum gifts areconsidered the most the issue and have provided parameters that should bethe considered establishing efficient approach for individuals with estates closer to $5 millionin federal such plan. estateatax exemption. Larger estates, however, will benefit greatly from combining these gifts with more advanced funding methods, such as loans or installment
sales, particularly the current, low interest environment. TAKE AWAY: given As corporate interest in deferred compensation plans increases, advisors can offer significant value to clients who are contemplating PRIOR REPORTS: 12-41; 12-22 the establishment of13-08; such plans by12-28; guiding them through a top-hat analysis that ensures (1) only a relatively small percentage of the workforce is invited to Prior to recent lawplan changes, holding life insurance through an irrevocable trust participate, (2)taxthe participants have executive or managerial employment was standard protocol for estate disparity planning, and it continues to serve many practical duties, (3) there is significant in the average compensation levels purposes.plan Individuals, however, consider the practicalities trust funding between participants andmust nonparticipants, and (4) theoflanguage of plan in order to select theparticipation most suitableto and tax-effective funding method for documents limits a select grouppremium of management or highly TOLI policies. compensated employees. WHY CONTINUE TO USE TOLI PRIOR REPORTS: 2013-30. Before 2013, most individuals placed lifev.insurance into an irrevocable life MAJOR REFERENCES: Darden Nationwide Mutual Insurance insurance trust order to prevent1989); taxation of the life Company, 717 (“ILIT”) F. Supp.in388 (E.D.N.C. Demery, et.insurance al. v. Extebank proceeds in the insured’s estate. The permanent increase in the federal Deferred Compensation Plan, 216 F.3d 283 (2d Cir. 2000); Bakriestate v. Venture, 1 tax exemption to $5.25 million, however, raises the question of whether many 473 F. 3d 677 (6th Cir. 2007); Cramer v. Appalachian Regional Healthcare, families need ILITs for estate planning. Inc., No.still 5:11-49-KKC (E.D. Ky.tax Oct. 29, 2012); Daft v. Advest, Inc., 658 F.3d 583 (6th Cir. 2011).
Yet TOLI remains beneficial for numerous reasons. A trust offers creditor protection beneficiaries in generated cases of bankruptcy or interest divorce) in anddeferring provides Recent taxfor rate increases (as have increased centralized (and possibly professional) wealth management, particularly for deferred compensation. To achieve this goal effectively, however, nonqualified younger beneficiaries arenot notonly prepared to handle large or suddentax ascensions compensation planswho must comply with the applicable laws (see to wealth. Further, ILITs limit exposure to state estate taxes in states with discussion in Washington Report No. 2013-30), but also qualify for the separate estate taximportant systems or substantive no state income taxes, which typically have much exemption from provisions of ERISA. lower exemptions than the federal estate tax exemption amount.
Leadership for Advanced Life Underwriting
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Washington Report
The trusted source of actionable technical and marketplace knowledge for AALU members - the nation’s most advanced life insurance professionals.
IMPACT OF ERISA
Topic: Funding Trust-Owned Life Insurance – Selecting the Best The AALU Washington Most nonqualified compensation plans (“NQDPs”) are considered “pension plans” within the Report is publisheddeferred by Option. meaning of ERISA, AALUniversity, a and, as such, are potentially subject to vesting, funding and fiduciary duty requirements. If those requirements it would, in most cases, produce immediate taxation on the amounts knowledge service ofapply the to a NQDP, MARKET TREND: Although a higher federal estate tax exemption means fewer deferred andtrusted subjectsource the employer tofamilies burdensome requirements. Tothe avoid thetrusts immediate taxation AALU. The will facefiduciary federal estate tax exposure, use of in life insurance of actionable deferred amounts, theand NQDP would have to satisfy the qualification rules under the Internal Revenue of technical plans will continue to serve numerous practical and tax planning needs. marketplace Code (“Code”knowledge or “IRC”), for which, most notably, would preclude the NQDP from discriminating in favor of AALU members—the nation’ the employer’s executives. Assa result, it is unlikely any employer would sponsor such an arrangement or SYNOPSIS: Planning with trust-owned life insurance (“TOLI”) must consider most advanced life insurance any employee would participate in one. An exception from these rules applies, however, for plans that are the funding of premiums into the trust. Numerous funding methods exist, professionals. considered top-hat plans. including: (1) annual exclusion gifts, (2) lump-sum gifts of gift and GST tax exemption, (3) split-dollar arrangements, (4) installment sales to ILITs or (5) The AALU Washington TOP-HAT PLANSby GENERALLY a combination thereof, with each method varying in terms of administrative Report is prepared the complexity and tax-efficiency. AALU staff and Greenberg The termone “top-hat is snot used in ERISA. Rather, it is a colloquialism developed to refer concisely to “a Traurig, of theplan” nation’ plan which unfunded an employer purpose of providing deferred leading lawisfirms in tax and andis maintained TAKE by AWAYS: TOLI isprimarily beneficialfor for the creditor and beneficiary protection compensation for a select group of management or highly compensated employees.” A plan that meets wealth management. purposes, wealth management, state estate tax planning, and income tax this description is exempt from the participation fiduciary dutymethod provisions of ERISA. planning.and The vesting, selection funding, of the bestand premium funding will depend on each Greenberg Traurig LLP family’s particular circumstances and goals, and the level of on-going support Jonathan M. Forster The requirements for top-hat plan exemption have been in insurance, ERISA, and unchanged, they will have from their tax,have and remained legal advisors (including since policy and Martin Kalb ERISA was enacted in 1974. In the nearly years since its enactment, the Department of gifts Labor funding40 reviews). Generally, annual exclusion or lump sum are(“DOL”) the most has Richard A. Sirus not provided (and likely will not provide) any official for or specific guidance clarifying a “select efficient approach individuals with estates closer what to theconstitutes $5 million federal Steven B. Lapidus group of management or highly compensated employees.” estate tax exemption. Larger estates, however, will benefit greatly from combining Rebecca Manicone these gifts with more advanced funding methods, such as loans or installment RELEVANT CASE LAW sales, particularly given the current, low interest environment. Counsel Emeritus Gerald H. Sherman 1932-2012 Notwithstanding the absence of DOLPRIOR guidance, a handful of court decisions reviewed whether a plan was Stuart Lewis 1945-2012 REPORTS: 13-08; 12-41; 12-28;have 12-22
a top-hat plan and thus provide some guidance for employers to consider in structuring NQDPs for top-hat plan exemption compliance. Prior to recent tax law changes, holding life insurance through an irrevocable trust
was standard protocol for estate planning, and it continues to serve many practical purposes. Individuals, however,717 mustF.consider practicalities trust funding 1. Darden v. Nationwide Mutual Insurance Company, Supp. the 388 (E.D.N.C.of1989). The in order select theplan most suitable (a) andittax-effective premium method for court held that the plan at issue was not to a top-hat because: was offered to morefunding than 18% of the company’s workforce, which the TOLI courtpolicies. did not consider to be a “select group,” and (b) in the court’s opinion,
the differences in the average compensation of plan participants ($31,528) as compared to all non-agent WHY CONTINUE TO USE TOLI was not sufficient to consider the plan employees ($19,121) and all management employees ($24,501) participants “highly compensated” within the meaning of ERISA.
Before 2013, most individuals placed life insurance into an irrevocable life (“ILIT”) in orderPlan, to prevent of the lifeCir. insurance 2. Demery, et. al. v. Extebank insurance Deferredtrust Compensation 216 taxation F.3d 283 (2d 2000). The proceeds the insured’s estate. The15.34% permanent increase in the federal estate court found that a plan was a top-hat planineven though it covered of the employer’s workforce. 1 tax exemption to $5.25atmillion, however, raises the question of whether many The court said that “[w]hile this number is probably or near the upper limit for the acceptable size for a families still need ILITs for estate tax planning. ‘select group,’ we cannot say that it alone made [the plan] too broad to be a top-hat plan....” As did other
courts, the Demery court applied a qualitative and quantitative analysis. The court found the following Yet TOLI beneficial numerous reasons. A trust plan: offers (a) creditor factors favorable to its determination thatremains the plan met thefor requirements for a top-hat that the protection for beneficiaries (as in cases of bankruptcy or divorce) and plan was limited to “highly valued managerial employees,” and (b) the average compensation of provides plan centralized (and compensation possibly professional) particularly for participants was more than double the average of the wealth entire management, workforce. Finally, the court younger beneficiaries who are not prepared to handle large or sudden ascensions noted that the inclusion of two or three employees who were not highly compensated or a select group of wealth. ILITs limit exposure to state in states with management did not prevent thetoplan fromFurther, being maintained “primarily” forestate these taxes employees.
separate estate tax systems or no state income taxes, which typically have much lower(6th exemptions than theThis federal estate tax exemption amount. 3. Bakri v. Venture, 473 F. 3d 677 Cir. 2007). court articulated essentially a four-part
Leadership for Advanced Life Underwriting
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Washington Report
The trusted source of actionable technical and marketplace knowledge for AALU members - the nation’s most advanced life insurance professionals.
test for assessing the top-hat status of a plan. Specifically, the court stated: “In determining whether a plan qualifies as a top-hat plan, we consider both qualitative and quantitative factors, including (a) the Topic: Funding Trust-Owned Life Insurance – Selecting the Best The AALU Washington percentage of theby total workforce invited to join the plan (quantitative), (b) the nature of their employment Report is published Option. duties (qualitative), (c) the compensation disparity between top-hat plan members and non-members AALUniversity, a (qualitative), and of the plan agreement (qualitative).” knowledge service of(d) thethe actual language MARKET TREND: Although a higher federal estate tax exemption means fewer
AALU. The trusted source families will face federal estate tax exposure, the use of trusts in life insurance Unlike thetechnical Darden and cases,will thecontinue Bakri case did numerous not give specific about the percentages of of actionable andDemery plans to serve practicaldetails and tax planning needs. marketplace knowledge for employees that participated in the plan or the range of salaries of those eligible and ineligible to participate AALU nation’ s in members—the the plan. Instead, in holding that the planPlanning was not with a top-hat plan, the noted that top-level company SYNOPSIS: trust-owned life court insurance (“TOLI”) must consider mostexecutives advanceddid lifenot insurance participate inthe thefunding plan, certain employees who were promoted to top management of premiums into the trust. Numerous funding methods exist, professionals. ceased to participate in the plan,including: and participation not limited tolump-sum top management orand even high-level (1) annualwas exclusion gifts, (2) gifts of gift GST tax positions (in fact, administrativeexemption, employees(3)and those who did not supervise other employees were split-dollar arrangements, (4) installment sales to ILITs or allowed (5) The AALU Washington to participate). Thus, that the plan at issue not meet varying the selectivity for a combination thereof, withdid each method in termsrequirement of administrative Report is prepared by thethe court felt consideration as a top-hat plan. complexity and tax-efficiency. AALU staff and Greenberg Traurig, one of the nation’s 4. Cramer v. Appalachian Regional Healthcare, No. 5:11-49-KKC Ky.protection Oct. 29, 2012). leading law firms in tax and TAKE AWAYS: TOLI isInc., beneficial for creditor and (E.D. beneficiary Themanagement. court applied the Bakri test purposes, to conclude that a plan was, in fact, a top-hat plan. In this case,tax however, wealth wealth management, state estate tax planning, and income the court articulated its application of each ofselection the elements the Bakri test. Specifically: planning. The of the of best premium funding method will depend on each Greenberg Traurig LLP family’s particular circumstances and goals, and the level of on-going support Jonathan M. Forster of total workforce invited to join the plan: Although the court noted that there is no a. Percentage they will have from their insurance, tax, and legal advisors (including policy and Martin Kalb bright-ine rule specifying what percentage ofGenerally, an employer’s can be covered a the top-hat funding reviews). annualworkforce exclusion or lump sum giftsby are most plan, Richard A. Sirus the plan in Cramer covered only 0.4% of the total workforce, which thecloser courttoweighed in favor of efficient approach for individuals with estates the $5 million federal Steven B. Lapidus meeting the “select group” requirement necessary for top-hat status. estate tax exemption. Larger estates, however, will benefit greatly from combining Rebecca Manicone these gifts with more advanced funding methods, such as loans or installment b. Nature of plan members’sales, employment duties: presented in the case indicated that particularly given the Evidence current, low interest environment. Counsel Emeritus H. some of the participants Gerald Sherman 1932-2012 in the plan did not exercise the authority or control generally associated with Lewis management and executive employees. However, noting the facts in other Stuart 1945-2012 PRIOR REPORTS: 13-08; 12-41; 12-28; 12-22 cases, including Demery, as
well as the DOL’s position in an earlier advisory opinion that provided that the fact that not all employees eligible to participate in a top-hat needholding to be management or highly employees, Prior to recent tax lawplan changes, life insurance through anpaid irrevocable trust the court found that this factor weighed in favor of finding the plan be a top-hat plan. wasalso standard protocol for estate planning, and itto continues to serve many practical
c.
order to select most suitableand and tax-effective premium funding method for Compensation disparity in between planthe participants nonparticipants: The court stated TOLI that qualification as a top-hat planpolicies. requires a significant disparity between the average compensation of plan participants and the average compensation of non-covered employees. Over the two years WHYW-2 CONTINUE TO USEofTOLI the court evaluated, the average compensation plan participants was more than 4.5 or 5 times the averages for nonparticipants. The court also noted that the compensation for the lowest paid plan Before 2013, mostfor individuals placed life insurance an irrevocable life participant was more than twice the average nonparticipants. The courtinto found that both of insurance trust (“ILIT”) in order to prevent taxation of the life insurance these facts supported treatment of the plan as a top-hat plan.
d.
1 tax exemption to $5.25 however,contained raises the question ofthat whether many Actual language of the plan document: Themillion, plan document language properly families still need ILITs for estate tax planning. restricted the group of employees eligible to participate, but the court noted that, notwithstanding the language of the Bakri test, a plan will not satisfy this criterion if the plan does not follow its Yet TOLI remains beneficial for numerous reasons. A trust offers creditor eligibility language in operation.
purposes. Individuals, however, must consider the practicalities of trust funding
proceeds in the insured’s estate. The permanent increase in the federal estate
protection for beneficiaries (as in cases of bankruptcy or divorce) and provides (and possibly professional) wealth management, In light of the foregoing factors, the centralized court concluded the plan was a top-hat plan within the particularly meaning offor ERISA. younger beneficiaries who are not prepared to handle large or sudden ascensions wealth. ILITs limit exposure statenot estate taxes in states withof 5. Daft v. Advest, Inc., 658 to F.3d 583Further, (6th Cir. 2011). Finally,to while providing the kind separate estate tax systems or no state income taxes, which typically have detailed analysis found in the Cramer case, the ruling in this case showed the court’s continued supportmuch for the lower exemptions than the federal estate tax exemption amount. Bakri test.
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TAKE-AWAY insurance professionals.
Despite the lack of formal agency guidance top-hatTrust-Owned exemption qualification, the foregoing decisions Topic:on Funding Life Insurance – Selecting the Best The AALU Washington provide a framework for evaluating whether a NQDP qualifies as a top-hat plan exempt from most ERISA Report is published by Option. requirements. can offer significant value to clients who are contemplating the establishment of a AALUniversity,Advisors a knowledge service of the NQDP by guiding them through a top-hat analysis that consider following factors: MARKET TREND: Althoughthe a higher federal estate tax exemption means fewer AALU. The trusted source
families will face federal estate tax exposure, the use of trusts in life insurance
of actionable technical and 1. Percentage of Workforce Invited to Participate: a relatively small the plans will continue to serveOnly numerous practical and percentage tax planningof needs. marketplace knowledge for employer’s workforce should be eligible to participate in the plan.
AALU members—the nation’s SYNOPSIS: Planning with trust-owned life insurance (“TOLI”) must consider most advanced life insurance 2. Nature of Participants’ Employment Most, nottrust. all, of the eligible employees should the fundingDuties: of premiums intoifthe Numerous funding methods exist, work professionals. in positions that provide them with executive management authority. including: (1) or annual exclusion gifts, (2) lump-sum gifts of gift and GST tax exemption, (3) split-dollar arrangements, (4) installment sales to ILITs or (5) The AALU Washington 3. Compensation Disparity between Participants and Nonparticipants: There should be a a combination thereof, with each method varying in terms of administrative Report is prepared by the significant disparity in the average compensation of employees eligible to participate in the plan and the complexity and tax-efficiency. AALU staff and Greenberg Traurig, onecompensation of the nation’of s ineligible employees. average leading law firms in tax and TAKE AWAYS: TOLI is beneficial for creditor and beneficiary protection wealth management. purposes, wealth management, estate tax planning, and income taxcontain 4. Language of Plan’s Documents & Plan Operation. Thestate applicable plan documents should The selection of the best or premium methodemployees, will depend and on each language limiting participation toplanning. a select group of management highly funding compensated the Greenberg Traurig LLP particular circumstances and goals, and the level of on-going support plan’s operation should conform family’s to that standard. Jonathan M. Forster they will have from their insurance, tax, and legal advisors (including policy and Martin Kalb funding reviews). Generally, annual exclusion or apply lump sum gifts Washington are the most In orderA.toSirus comply with requirements imposed by the IRS which may to the Richard efficient approach formembers, individuals with estates to the million federal Report asLapidus distributed or as re-circulated by our please becloser advised of$5the following: Steven B. estate tax exemption. Larger estates, however, will benefit greatly from combining Rebecca Manicone these gifts with more advanced funding methods, such as loans or installment THE ABOVE ADVICE WAS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE sales, particularly given theANY current, low interest environment. CounselBY Emeritus USED, YOU FOR THE PURPOSES OF AVOIDING PENALTY THAT MAY BE IMPOSED Gerald H.INTERNAL Sherman 1932-2012 BY THE REVENUE SERVICE. Stuart Lewis 1945-2012 PRIOR REPORTS: 13-08; 12-41; 12-28; 12-22
In the event that this Washington Report is also considered to be a “marketed opinion” within Prior to recent tax law changes, life insurance throughadvised an irrevocable trust the meaning of the IRS guidance, then, as required by theholding IRS, please be further of the was standard protocol for estate planning, and it continues to serve many practical following: purposes. Individuals, however, must consider the practicalities of trust funding order to select most suitable and PROMOTIONS tax-effective premium method for THE ABOVE ADVICE WAS NOTinWRITTEN TOthe SUPPORT THE ORfunding MARKETING TOLI policies. OF THE TRANSACTIONS OR MATTERS ADDRESSED BY THE WRITTEN ADVICE, AND,
BASED ON THE PARTICULAR CIRCUMSTANCES, YOU SHOULD SEEK ADVICE FROM AN INDEPENDENT TAX ADVISOR.WHY CONTINUE TO USE TOLI
Before 2013, most individuals placed life insurance into an irrevocable life insurance trust (“ILIT”) in order to prevent taxation of the life insurance proceeds in the insured’s estate. The permanent increase in the federal estate tax exemption to $5.25 million,1 however, raises the question of whether many families still need ILITs for estate tax planning. Yet TOLI remains beneficial for numerous reasons. A trust offers creditor protection for beneficiaries (as in cases of bankruptcy or divorce) and provides centralized (and possibly professional) wealth management, particularly for younger beneficiaries who are not prepared to handle large or sudden ascensions to wealth. Further, ILITs limit exposure to state estate taxes in states with separate estate tax systems or no state income taxes, which typically have much lower exemptions than the federal estate tax exemption amount.