Conventional wisdom says that the more you can put into your pension plan, Keogh or IRA, the better off you are. Think again, say some estate planners.
Retirement plans are great when you're alive-you get tax deferral, a nice write-off and protection from creditors. But your heirs might see it differently. A large IRA rollover, for example, can get whacked for up to 70% or more upon death.
What to do? Some of the conventional techniques involve using life insurance trusts. When the client dies, the proceeds go to pay estate taxes.
There's another idea a few planners are using for clients still in the accumulation stage: A Voluntary Employee's Beneficiary Association (VEBA). VEBAs have been around since 1928 but until recently, scarcely used. A VEBA is basically a benefit plan that allows virtually unlimited contributions-all deductible.
VEBAs act as pension supplements using variable and/or term life insurance. A business can contribute to a VEBA for its employees to provide death-, education-, long-term disability and other benefits. Participants do not have to withdraw at age 701/2, are not subject to penalties for withdrawals before age 591/2 and can make large contributions.
The IRS code that allows VEBAs is 501(c)9-part of the tax-exempt code. Non-profits file under 501(c)3. You'll need to find a trustee and a plan, but be careful here. "Just because a sponsor says they have a VEBA doesn't make it so," says Lance Wallach, a VEBA consultant in Plainview, N.Y. According to Wallach, a letter of determination from the IRS is a prerequisite for a VEBA provider. The letter of determination is important because the odds of your plan being thrown out are low if the IRS has written the letter saying the plan is legitimate.
For many, it may be easier to use a multiple employer VEBA plan authorized under Section 419A(f)(6). Under this arrangement, the IRS authorizes several employers to pool their services with a trustee for cost savings and convenience. New employers that sign on with a multiple employer plan can then use an existing approved prototype. The trustee, which is usually a bank, directs the funds to an insurance policy.
The fees on a VEBA will run around $2,500 a year, so the client has to make large enough contributions to make it worthwhile. Wallach recommends $25,000 or more per year.
You can't discriminate against employees in a VEBA-everyone must get the same relative benefit. That's why Wallach feels VEBAs are most attractive to closely held and professional corporations with few employees and highly paid principals.
Say benefits are fixed at death at 10 times salary. The owner makes $200,000 and will get a $2 million benefit. Two employees make $20,000 and get $200,000. The plan buys term insurance for the employees and a variable life policy for the owner, who contributes $50,000 and gets to write it all off. The only tax paid by the employee is based on the economic benefit of the life insurance, usually the published term rate. Eventually, the owner can add educational and other benefits as the need arises. When an employee leaves, they have no vested interest in the plan.
Consider using an insurance expert for help in setting up a plan for a client (Wallach is at 516/935-7346.) An Internet search found several other VEBA-purveyor sites, the most interesting of which is the (Barry) Kaye Group, www.taxsaver.com, which has a good overview. Also, Haynes and Boone, an employee benefits law firm mentions it in their home page (www.hayboo.com).
Given the number of fully funded retirement plans (see sidebar), VEBAs could catch on.
There was standing room only. All it took was a two-inch ad and the "pension consultants" could fill a room with anesthesiologists, cardiologists, dentists and other assorted professionals.
The pitch? How to put more than a mere 25% of your income or $30,000 into a tax-sheltered, deductible pension plan. Anything to save taxes. Most of the people in the room at a recent seminar in Southern California were in their early 40s or younger and desperate to hear somebody talk about what to do with their fully funded defined benefit plans.
Defined benefit plans are designed around a fixed pension when you retire. By using an actuarial calculation, you can determine how much you can put aside now to maintain your current income. So, if you're older and making a lot of money, this can be a great deal, or so it seemed. The problem is that if you're good at picking your investments, you might not be able to add any money in later years.
It used to be that you were overfunded at 150% of the current value needed to fund future benefits, but the new tax law raises this to 170%, according to the Pension Benefit Guaranty Corp. If you reach this threshold, you have to take a contribution "holiday." In other words, you can't put in more money.
A lot of defined benefit plans are invested in stocks. Many of these plan holders are prime targets for VEBAs and other non-qualified plans.
Here's an idea of how big the market could be. With the help of Judy Diamond & Associates, RR searched a database for small plans with large assets, and a large percentage in stocks at some time in the past three years. In one Southern California zip code alone, over 50 plans met our criteria.
(The Diamond database-in book or CD-ROM-includes plan name; telephone number; value of stock, bond and other holdings updated every three years; current advisers and administrators, etc. Cost: $195 to more than $700, depending on the area covered. Phone: 800/231-0669.)