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Insurance Abstract
A system and method for providing insurance protection against loss
of contributions to tax favored defined contribution plans should
an active employee/participant become disabled. The invention manages
the administration of a disability insurance policy held inside
the plan that continues contributions to the plan during a period
of disability, where the coverage amount for each participant is
determined by the level of contributions made by, or for, each participant.
Insurance Claims
1. A method for using a computer processing system to calculate
benefit and cost amounts under a disability insurance policy so
as to provide substitute continuing payments to a retirement plan
into which contribution payments are normally made on behalf of
a participant of the plan, during a period of non-payment due to
a long-term disability of the plan participant, said disability
insurance being included as a feature of the plan and held as an
asset of the plan's trust, and said insurance premiums being paid
with assets of the trust, the method comprising: a. inputting into
said computer system information relating to said participant's
pre-disability contribution amount; b. based on said information,
calculating with the computer system a premium amount for the insurance
policy and a disability benefit amount under the insurance policy,
said disability benefit amount being substantially equal to the
pre-disability contribution amount; and c. paying said disability
benefit into the retirement plan's trust as an investment return
of the trust, wherein the retirement plan is subject to non-discrimination
requirements with regard to eligibility for the insurance, and eligibility
for the insurance is matched to eligibility for the plan, or to
participation in the plan, or both, for the plan year prior to the
policy year for which the insurance is effective.
2. The method of claim 1, wherein the retirement plan is a tax
qualified defined contribution 401(a) plan, thereby subjecting said
insurance policy to the terms of said defined contribution plan,
including rules and regulations of the Internal Revenue Service
(IRS) and the Department of Labor (DOL) to which the defined contribution
plan itself is subject.
3. The method of claim 1, wherein the retirement plan is a member
selected from the group consisting of a 401(k) plan, a 403(b) plan,
a 457 plan, a defined benefit pension plan, and a money purchase
pension plan.
4. The method of claim 1, wherein the trust includes an individual
account allocated to each participant and the insurance premium
for each said participant is paid from said participant's account.
5. The method of claim 1, further including calculating a total
annual premium for all plan participants, wherein said total annual
premium is paid on an overall-plan basis from the trust as a plan
expense.
6. The method of claim 5, wherein the trust includes an individual
account allocated to each participant and said total annual premium
is paid from the earnings of the trust prior to the earnings being
allocated to said individual participant accounts.
7. A method for using a computer processing system to calculate
benefit and cost amounts under a disability insurance policy so
as to provide substitute continuing payments to a retirement plan
into which contribution payments are normally made on behalf of
a participant of the plan, during a period of non-payment due to
a long-term disability of the plan participant, said disability
insurance being included as a feature of the plan and held as an
asset of the plan's trust, and said insurance premiums being paid
with assets of the trust, the method comprising: a. inputting into
said computer system information relating to said participant's
pre-disability contribution amount; b. based on said information,
calculating with the computer system a premium amount for the insurance
policy and a disability benefit amount under the insurance policy,
said disability benefit amount being substantially equal to the
pre-disability contribution amount; and c. paying said disability
benefit into the retirement plan's trust as an investment return
of the trust, wherein the plan is subject to non-discrimination
requirements with regard to premiums for the insurance and benefits
under the insurance, and said premiums and benefits are linked to
pre-disability contributions to the plan for the plan year prior
to the policy year for which the insurance is effective, said pre-disability
contributions having been demonstrated to meet the plan's non-discrimination
requirements by definition or by testing.
8. The method of claim 7, wherein the retirement plan is a tax
qualified defined contribution 401(a) plan, thereby subjecting said
insurance policy to the terms of said defined contribution plan,
including rules and regulations of the Internal Revenue Service
(IRS) and the Department of Labor (DOL) to which the defined contribution
plan itself is subject.
9. The method of claim 7, wherein the retirement plan is a member
selected from the group consisting of a 401(k) plan, a 403(b) plan,
a 457 plan, a defined benefit pension plan, and a money purchase
pension plan.
10. The method of claim 7, wherein the trust includes an individual
account allocated to each participant and the insurance premium
for each said participant is paid from said participant's account.
11. The method of claim 7, further including calculating a total
annual premium for all plan participants, wherein said total annual
premium is paid on an overall-plan basis from the trust as a plan
expense.
12. The method of claim 11, wherein the trust includes an individual
account allocated to each participant and said total annual premium
is paid from the earnings of the trust prior to the earnings being
allocated to said individual participant accounts.
13. The method of claim 7, wherein said premiums and benefits are
linked to contributions to the plan that, in accordance with the
IRC and its attendant rules and regulations, are based on a non-discriminatory
formula.
14. The method of claim 7, wherein said premiums and benefits are
linked to contributions to the plan that are equal to a fixed percentage
of compensation for all participants in the plan.
15. A machine-readable medium for use in a machine having a central
processing unit (CPU), the medium containing program instructions
executable by the CPU to cause the machine to perform a method of
determining benefit and cost amounts under a disability insurance
policy so as to provide substitute continuing payments to a retirement
plan into which contribution payments are normally made on behalf
of a participant of the plan, during a period of non-payment due
to a long-term disability of the plan participant, the method comprising:
a. receiving information relating to said participant's pre-disability
contribution amount; and b. calculating, based on said information
and in accordance with the insurance policy and plan provisions,
a premium amount for the insurance policy and a disability benefit
amount under the insurance policy, said disability benefit amount
being substantially equal to the pre-disability contribution amount,
wherein the disability insurance is included as a feature of the
plan and held as an asset of the plan's trust, the insurance premiums
are to be paid with assets of the trust, and the disability benefits
are to be paid into the trust.
16. The machine-readable medium according to claim 15, wherein
said method further comprises accounting premiums paid for, and
benefits paid under, said insurance policy.
17. The machine-readable medium according to claim 16, wherein
said accounting of premiums includes calculating a total annual
premium for all plan participants and allocating the total premium
as a plan expense.
18. The machine-readable medium according to claim 15, wherein
said method further comprises determining said plan participant's
potential eligibility to be a member of a group insured under said
insurance policy.
19. The machine-readable medium according to claim 18, wherein,
in accordance with the provisions of the Internal Revenue Code (IRC)
and its attendant rules and regulations, the plan is subject to
non-discrimination requirements, and wherein said method further
comprises determining compliance with said requirements.
20. The machine-readable medium according to claim 15, wherein
the retirement plan is a tax qualified defined contribution 401(a)
plan.
21. The machine-readable medium according to claim 20, wherein
the insurance policy is subject to the terms of the defined contribution
plan, including rules and regulations of the Internal Revenue Service
(IRS) and the Department of Labor (DOL) to which the defined contribution
plan itself is subject.
22. The machine-readable medium according to claim 15, wherein
the retirement plan is a member selected from the group consisting
of a 401(k) plan, a 403(b) plan, a 457 plan, a defined benefit pension
plan, and a money purchase pension plan.
23. The machine-readable medium according to claim 22, wherein
the insurance policy is subject to the terms of the retirement plan,
including rules and regulations of the Internal Revenue Service
(IRS) and the Department of Labor (DOL) to which the retirement
plan itself is subject.
24. A machine-readable medium used in a machine having a central
processing unit (CPU), the medium containing program instructions
executable by the CPU to cause the machine to perform a method of
determining benefit and cost amounts under a disability insurance
policy so as to provide substitute continuing payments to a retirement
plan into which contribution payments are normally made on behalf
of a participant of the plan, during a period of non-payment due
to a long-term disability of the plan participant, wherein the disability
insurance is included as a feature of the plan and held as an asset
of the plan's trust, the insurance premiums are paid with assets
of the trust and the disability benefits are paid into the trust,
and the plan is subject to non-discrimination requirements with
regard to eligibility for the insurance, the method comprising:
a. receiving information relating to said participant's pre-disability
contribution amount; b. determining said participant's eligibility
for the insurance by matching eligibility for the insurance to eligibility
for the plan, matching eligibility for the insurance to participation
in the plan, or both, for the plan year prior to the policy year
for which the insurance is effective; and c. calculating, based
on said information and in accordance with the insurance policy
and plan provisions, a premium amount for the insurance policy and
a disability benefit amount under the insurance policy, said disability
benefit amount being substantially equal to the pre-disability contribution
amount.
25. The machine-readable medium according to claim 24, wherein
said method further comprises accounting premiums paid for, and
benefits paid under, said insurance policy.
26. The machine-readable medium according to claim 25, wherein
said accounting of premiums includes calculating a total annual
premium for all plan participants and allocating the total premium
as a plan expense.
27. The machine-readable medium according to claim 24, wherein
the retirement plan is a member selected from the group consisting
of a 401(k) plan, a 403(b) plan, a 457 plan, a defined benefit pension
plan, and a money purchase pension plan.
28. A machine-readable medium used in a machine having a central
processing unit (CPU), the medium containing program instructions
executable by the CPU to cause the machine to perform a method of
determining benefit and cost amounts under a disability insurance
policy so as to provide substitute continuing payments to a retirement
plan into which contribution payments are normally made on behalf
of a participant of the plan, during a period of non-payment due
to a long-term disability of the plan participant, wherein the disability
insurance is included as a feature of the plan and held as an asset
of the plan's trust, the insurance premiums are paid with assets
of the trust and the disability benefits are paid into the trust,
and the plan is subject to non-discrimination requirements with
regard to premiums for the insurance and benefits under the insurance,
the method comprising: a. receiving information relating to said
participant's pre-disability contribution amount; b. calculating,
based on said information and in accordance with the insurance policy
and plan provisions, a premium amount for the insurance policy and
a disability benefit amount under the insurance policy, said disability
benefit amount being substantially equal to the pre-disability contribution
amount; and c. linking said premium and benefit amounts to pre-disability
contributions to the plan for the plan year prior to the policy
year for which the insurance is effective, said pre-disability contributions
having been demonstrated to meet the plan's non-discrimination requirements
by definition or by testing.
29. The machine-readable medium according to claim 28, wherein
said method further comprises accounting premiums paid for, and
benefits paid under, said insurance policy.
30. The machine-readable medium according to claim 29, wherein
said accounting of premiums includes calculating a total annual
premium for all plan participants and allocating the total premium
as a plan expense.
31. The machine-readable medium according to claim 28, wherein
the retirement plan is a member selected from the group consisting
of a 401(k) plan, a 403(b) plan, a 457 plan, a defined benefit pension
plan, and a money purchase pension plan.
32. A computer processing system having instructions for effecting
substitute continuing payments into a trust of a retirement plan,
into which contribution payments are normally made on behalf of
a participant of the plan, during a period of non-payment due to
a long-term disability of the plan participant, said system comprising:
a. a disability system having a disability database that stores
data relating to an insurance policy, wherein: (i) the insurance
policy is a feature of said retirement plan; (ii) the insurance
policy is held as an asset of the plan's trust; (iii) premiums for
the insurance policy are paid with assets of the trust; and (iv)
benefit payments under the insurance policy are paid into the trust;
b. a record-keeping system having a record-keeping database that
stores data relating to one or more sources of money that are deposited
into the plan's trust and one or more funds into which trust assets
are invested; c. means for transmitting data from the record-keeping
system to the disability system; d. means for calculating, based
on said data transmitted to the disability system, said premiums
in an amount so that the benefit payments are substantially equal
to the pre-disability contribution payments; and e. means for accounting
premiums paid for, and benefits paid under, said insurance policy.
33. The system of claim 32, further comprising means for determining
said participant's potential eligibility to be a member of a group
insured under said insurance policy.
34. The system of claim 32, wherein, in accordance with the provisions
of the Internal Revenue Code and its attendant rules and regulations,
the plan is subject to non-discrimination requirements, and wherein
the system further comprises means for determining compliance with
said requirements.
35. The system of claim 32, wherein the retirement plan is a tax
qualified defined contribution 401(a) plan.
36. The system of claim 35, wherein the insurance policy is subject
to the terms of the defined contribution plan, including rules and
regulations of the Internal Revenue Service (IRS) and the Department
of Labor (DOL) to which the defined contribution plan itself is
subject.
37. The system of claim 32, wherein the retirement plan is a member
selected from the group consisting of a 401(k) plan, a 403(b) plan,
a 457 plan, a defined benefit pension plan, and a money purchase
pension plan.
38. The system of claim 37, wherein the insurance policy is subject
to the terms of the retirement plan, including rules and regulations
of the Internal Revenue Service (IRS) and the Department of Labor
(DOL) to which the retirement plan itself is subject.
39. The system of claim 32, wherein the trust includes an individual
account allocated to each participant, the record-keeping database
stores said source and fund data in accordance with each participant's
account, and the insurance premium for each said participant is
paid from said participant's account.
40. The system of claim 32, wherein said premiums and benefits
are linked to contributions to the plan that, in accordance with
the IRC and its attendant rules and regulations, are based on a
non-discriminatory formula.
Insurance Description
RELATED APPLICATION DATA
[0001] This is a continuation of application Ser. No. 09/328,856,
filed Jun. 9, 1999, now U.S. Pat. No. ______, which claims the benefit
of provisional application Ser. No. 60/088,969, filed Jun. 10, 1998.
BACKGROUND OF THE INVENTION
[0002] 1. Field of the Invention
[0003] The present invention relates generally to the field of
employee benefits, and more specifically to systems and methods
for insuring against loss of retirement benefits. Yet more particularly,
the invention relates to, and is applied to, retirement plans established
under United States Tax Law, and under Title 26 of the United States
Internal Revenue Code.
[0004] 2. Description of the Related Art
[0005] Employee benefits are generally divided into welfare benefits
(such as health care, disability and life insurance), qualified
retirement benefits (may take the form of defined benefit pension
plans or defined contribution plans), and non-qualified plans (such
as executive wealth accumulation programs).
[0006] Under a defined benefit plan, the plan document sets forth
a formula for determining the amount of monthly retirement income
to be paid to an employee after he/she reaches normal retirement
(or some earlier retirement age). This formula is based on the employee's
length of service or a combination of the employee's length of service
and pay (either career pay or final average pay). The benefit is
provided from a trust or annuity contract to which usually only
the employer contributes. The amount of contributions necessary
to provide the promised benefits for the covered work force is determined
under minimum standards set out in federal law and the actual annual
contribution amount is determined by the employer with the assistance
of an actuary. Each employee's benefit is insured by a federal agency
(called the "Pension Benefit Guaranty Corporation" or
"PBGC") and because of the minimum funding standards and
the PBGC insurance, benefits to the employee are not solely dependent
on the accumulations in the trust on behalf of the employee.
[0007] Defined contribution plans are retirement programs where
the employee's final retirement benefit is determined solely by
the value of an "account" that has been established within
the plan for the benefit of the employee. Contributions to that
account and investment gains or losses of the account during the
employee's working career, are paid to the employee at normal retirement
age (or some earlier age) as specified in the plan document. As
is evident, the amount of the employee's retirement benefit is directly,
and entirely, related to the accumulations in the employee's account.
The PBGC does not insure defined contribution plans. Employers make
contributions to defined contribution plans using some non-discriminatory
formula, such as a percentage of each employee's compensation as
defined by the plan. In addition, if the plan has a 401(k) feature
(26 United States Code 401(k)), employers may make contributions
to the plan based on an employee's election to defer a portion of
his/her cash compensation into the plan (such contributions are
called "employee deferrals"). Plans with 401(k) features
often allow for special employer contributions called "employer
matching contributions" whereby the employer will make an additional
contribution to the employee's account based on the amount of deferral
the employee elects.
[0008] (References to code sections herein, such as 401(k), 401(m),
410(b), 415(c), etc. shall be understood to refer to sections of
the United States Internal Revenue Code, United States Code, Title
26.)
[0009] All qualified retirement plans are required to adhere to
strict tax laws and regulations set forth in the Employee Retirement
Income Security Act of 1974 (ERISA), the Internal Revenue Code of
1986 as amended (IRC), various Revenue Rulings and Procedures, and
Department of Labor regulations. The general standards of accuracy
and completeness are unusually high. The IRS demands that plans
comply both "in form" and "in operation" with
the tax "qualification requirements." Compliance "in
form" means that the plan document language must comply with
all applicable tax laws and regulations (as interpreted by the IRS).
Compliance "in operation" means that the plan must be
administered in strict adherence to its written provisions--even
provisions that have been adopted solely for design reasons (and
would not have needed to have been adopted to achieve "qualified"
status). Both form defects and operational defects may result in
the IRS "disqualifying" the plan or imposing a "correction
program" on the plan. Either result would have enormous financial
implications for the employer sponsoring the defective plan; therefore,
employers are extremely careful to see that their plans comply with
all regulations in regard to both features and practices.
Loss of Current Income
[0010] The loss of income during a period of long-term disability
has generally been addressed under an employer's welfare benefits
through a long-term disability plan. The employer may choose to
fund this plan through the use of a group long-term disability contract,
individual insurance contracts, a self-insurance arrangement, or
a combination of the above. This plan partially replaces the loss
of regular earnings that would otherwise be paid during the employee's
period of disability. Benefits under these disability programs typically
stop at the individual's "ADEA cut-off age." For a person
who becomes disabled prior to the attainment of age 60, the ADEA
cut-off age is usually age 65. For workers who become disabled after
attaining age 60, the ADEA cut-off age is usually five years after
the commencement of disability payments. This plan typically does
not address the needs of disabled employees after retirement age.
At retirement, a disabled employee's disability benefit will cease
and income must be provided by a combination of Social Security
benefits, qualified retirement plan benefits, and personal savings.
Loss of Retirement Benefits
[0011] Employees who have been covered by a defined benefit plan
for most of their working career may have a portion of their retirement
income needs met by their qualified retirement plan benefits, even
if they suffer a long-term disability during their career. Defined
benefit plans may provide that if a participant becomes disabled,
service, and if applicable, pay, would be deemed to continue for
purposes of determining the amount of the retirement benefit provided
under the plan's formula. Some plans also commence paying benefits
at the time of disability and continue paying benefits throughout
retirement.
[0012] In contrast, under the typical defined contribution plan,
if a participant becomes disabled and remains disabled beyond a
period of "short-term disability" (during which the employee
is usually compensated through the regular payroll), contributions
to the employee's account under the plan will cease. Therefore,
an active employee is at risk that if he/she should become disabled
and contributions to the plan are not made, the value of his/her
plan account at the commencement of retirement will be substantially
less than it would be if he/she had not become disabled. The reduction
in the value of the employee's account will produce a direct loss
of retirement income to the employee. If the plan allows benefits
to be paid at disability, the available benefits are based on the
accumulations in the account to date, and immediate payment of benefits
from the account increase the likelihood that the account will be
depleted before retirement age, further exaggerating the problem.
Since the introduction of 401(k) plans, many employers have entirely,
or significantly, shifted the focus of their retirement benefits
from defined benefit plans to defined contribution plans, often
with a 401(k) feature, making this disability risk a reality for
millions of employees.
[0013] The potential loss of retirement account values at age 65
(usually considered to be the "normal retirement age")
assuming disability occurs at certain ages that last for certain
periods of time can be illustrated as follows:
Quantifying the Exposure
[0014] The diminution in inflation adjusted retirement income for
every $1000 of annual employer pre-tax or employer matching contribution:
TABLE-US-00001 If disability And continues to age: occurs at age:
35 45 55 65 25 $52,500 $88,071 $112,071 $128,357 35 $35,357 $59,357
$75,642 45 $24,000 $39,428 55 $16,071 The chart expresses the individual's
loss in inflation adjusted income attributable to the assumed $1000
of annual contribution that would have been made had the disablement
not occurred.
Assumptions: [0015] 1. 4% real rate of return (that is, inflation
adjusted). [0016] 2. Plan withdrawals over 15 years starting at
age 65. [0017] 3. No salary scale. (That is, it was assumed that
this individual's compensation would not have increased during the
period he/she was disabled).
[0018] In the foregoing chart, it was assumed that the individual's
compensation would have remained the same during the period of disability.
However, if it is assumed that the individual's compensation would
have increased by a certain percentage (e.g., a commonly used "salary
scale" such as 5% per year), the losses would be proportionately
greater.
"Outside the Plan" Arrangements
[0019] Until the introduction of the invention, employers did not
think it was possible to address this risk inside the 401(k) and
other retirement plans by including disability insurance as a feature
of the plan. Even though retirement plans may include "incidental
health and welfare" benefits, there was no known way to structure
the insurance without complicating the "non-discrimination"
requirements that apply to all "benefits, rights or features"
for plans subject to IRS Section 410(b) testing. Therefore, some
employers have attempted to deal with this risk on the part of their
employees by using various funding arrangements outside of the retirement
plan. Each outside the plan arrangement presents significant problems.
Arrangement One--Increase the Group LTD Benefits
[0020] Some employers have increased the benefits payable under
their group long-term disability (LTD) contract, or their long-term
disability program, to cover the potential loss. For example, an
employee who elects a 6% deferral and receives a 4% match to the
401(k) plan, might receive an additional 10% of pay benefit under
the regular, or a supplemental, group LTD policy. There are three
main problems with this approach. [0021] Problem One--The insurance
may not be "linked" to employee deferrals. Tax policy
requires that no other benefits may be contingent upon an employee's
deferral election under a 401(k) plan. If the employer links the
amount of coverage under a group LTD policy directly or indirectly
to the level of employee deferrals and/or employer matching contributions
under a 401(k) plan, contributions to the plan will cease to be
viewed as "elective deferral contributions" under the
federal tax laws. And, since highly compensated employees and non-highly
compensated employees elect deferrals at differing percentages of
compensation, without the special tests applicable to deferrals,
these contributions would not be able to pass the non-discrimination
requirements. Alternatively, for the employer to set an arbitrary
amount of insurance based on average contributions would result
in some employees having their account funded more heavily if they
become disabled, and other employees having their account under-funded
in the event of disability. [0022] Problem Two--The employee may
be "over-insured." Actuaries at most insurance companies
are of the view that increasing the cash benefit payable during
a disability will have an adverse impact on the rate at which some
disabled individuals respond to rehabilitation. This is especially
true if the benefit is provided on a tax-free basis, which is the
design under many employers' group LTD programs. This risk of over-insurance
would require a substantial, disproportionately large increase in
the risk charge that must be imposed as part of the premium for
the group LTD policy. Similarly, this over-insurance could create
a substantial increase in benefit payments in a self-insured LTD
program. [0023] Problem Three--The employee may not save the benefit
for retirement. If the employee spends the additional benefit before
his/her retirement years, the employer's objective will not have
been achieved and the employee still has a significant risk of loss
at retirement.
Arrangement Two--Continue Employer Contributions to the Plan
[0024] Some employers have attempted to deal with the employee's
loss of contributions during a long-term disability by continuing
to make contributions to the plan on behalf of the employee during
the period of disability equal to the pre-disability level of contributions.
There are three main problems with this approach. [0025] Problem
One--Difficulty with IRC Section 415(c). Certain tests are prescribed
under IRC Section 415(c) that determine the maximum annual additions
allowed to the plan in a plan year. This generally limits contributions
to a defined contribution plan to 25% of the employee's taxable
compensation paid by the employer. Since a disabled individual is
receiving no compensation directly from the employer, the contribution
limit becomes zero (25% multiplied by $0 compensation). A special
provision of the tax laws permits the limit to be applied by assuming
that a disabled employee's compensation continues during a period
of disability at the same level that it was prior to the commencement
of disability. However, the rule applies only if the participant
is disabled under a very restrictive "any occupation"
definition of disability. If an employer wishes to use a less restrictive
"own occupation" definition of disability for the first
two to five years following the commencement of disability (as most
employers would desire), the special rule provides no relief for
the tests prescribed under IRC Section 415. [0026] Problem Two--Difficulty
with Non-Discrimination Tests. Contributions that are made by the
employer on behalf of disabled employees who are "highly compensated
employees" ("HCE" as defined by tax laws) may have
difficulty passing non-discrimination tests. Contributions that
are made by, employers on behalf of disabled employees under this
approach may not be tested as matching contributions under 401(m)
after the first 12 months. IRC Section 401(k) and 401(m) describe
the parameters for allowing higher levels of deferrals and matching
contributions to be made (on the average) by, or for, HCEs than
are made (on the average) by, or for, non-HCEs. Since HCEs almost
always make larger percentage of pay contributions than non-HCEs,
if the employer continues the same level of contributions that it
was making for the disabled individual prior to the disability and
these tests no longer apply, the contributions would almost certainly
be considered discriminatory. [0027] Problem Three--The Benefit
is Not Insured. An employer who decides to continue contributions
during a long-term disability could also have a change of heart.
The employer could choose to unilaterally cut back the continuing
contribution--even with respect to persons who are already disabled.
And the disabled individual is at risk that the employer will go
bankrupt. Even if the employer has insured its risk, the benefits
payable after bankruptcy would be retained by the estate of the
bankrupt employer and would benefit all of the employer's general
creditors (including the employees) on a pro-rata basis.
Arrangement Three--Continue Employee Contributions from LTD Benefits
[0028] Some employers permit a disabled employee to make contributions
to the 401(k) plan out of the benefit he/she is receiving from the
group LTD plan. There are three main problems with this approach.
[0029] Problem One--The LTD Benefit Must Be Taxable to the Employee.
This approach avoids the IRC Section 415 and non-discrimination
problems noted as Problem One and Two above only if the group LTD
benefit is taxable to the employee. A number of employers have structured
their group LTD benefit in such a way that the benefit under the
group LTD policy is (or, at the election of the employee, can be)
tax free. Employees would be giving up a significant tax advantage
and a significant amount of disability income in order to be able
to contribute a portion of the benefit to the 401(k) plan. [0030]
Problem Two--The 401(k) Plan and LTD Plan Must Cover Non-HCEs Equally.
This approach is likely to avoid a discrimination problem with regard
to availability only if most of the non-HCEs participating in the
401(k) plan are also participants in an LTD program that provides
the same (or higher) percent of pay benefits than are provided to
most of the HCEs. The minimum coverage standards of ERISA applicable
to the 401(k) plan require coverage for many employees who work
part-time (i.e., at least 1000 hours per year). These ERISA standards
do not apply to the group LTD program and many employers do not
provide LTD coverage to part-time employees. If a sufficient proportion
of non-HCEs who are participants in the 401(k) plan are not participants
in the LTD program, the availability of disability coverage under
the 401(k) plan may not pass non-discrimination tests. [0031] Problem
Three--An HCE's Loss Cannot be Fully Covered. Because of the application
of the 401(k) and 401(m) non-discrimination tests with regard to
average contributions for HCEs and non-HCEs, an HCE may not be able
to replace his/her entire pre-disability contribution. For example,
consider an HCE who was contributing 6% of pay to the 401(k) plan,
becomes disabled, and receives a 60% of pay LTD benefit. In order
to continue his/her old contribution amount, he/she would need to
contribute 10% of the LTD benefit. Such an increase in the deferral
percentage for disabled HCEs would no doubt increase the average
percentage for the HCE group and may result in failure of the 401(k)
and/or (m) tests.
SUMMARY OF THE INVENTION
[0032] The method and system of the present invention are adapted
to overcome the above-noted shortcomings and to fulfill the stated
needs. The essence of one aspect of the invention is a method for
making substitute continuing periodic payments into an investment
account normally paid from a specific source, during a period of
nonpayment from the specific source, wherein the nonpayment is due
to a particular condition. This method comprises the steps of: purchasing,
with funds of an investment account an insurance policy to make,
upon occurrence of a particular condition causing a period of nonpayment
to the investment account, substitute payments to the investment
account in amounts approximately equal to those paid from a specific
source before the period of nonpayment; and, paying, upon occurrence
of the particular condition, benefits under the insurance policy
into the investment account. This inventive method is applied effectively
to retirement accounts, and especially to defined contribution plan
accounts, to prevent loss of accumulations during an employee's
disability.
[0033] The inventive system serves similar purposes, and comprises
the following elements: an insurance policy adapted to make, upon
occurrence of a particular condition causing a period of noncontribution
to a potentially-eligible employee's retirement plan account, substitute
contributions to the plan account in amounts approximately equal
to those made by the potentially-eligible employee and/or by the
potentially-eligible employee's employer before a period of noncontribution;
means for collecting and storing potentially-eligible employee indicative
data; means for determining an employee's potential eligibility
to be a member of a group insured under the insurance policy; means
for calculating periodic premiums for each potentially-eligible
employee for appropriate coverage under the insurance policy; means
for accounting premiums paid for the insurance policy; means for
accounting benefits paid under said insurance policy; and, means
for deducting calculated premium amounts from plan assets.
Invention Effectively Replaces Lost Contributions
[0034] The effectiveness of the invention in replacing lost contributions
can be illustrated by examining the account values of four equally
contributing plan participants at four different ages (35, 45, 55,
65). For each of the four individuals, final account value will
be determined by one of these four situations:
[0035] a) He/she does not have the invention and does not become
disabled;
[0036] b) He/she has the invention and does not become disabled;
[0037] c) He/she does not have the invention and becomes disabled;
[0038] d) He/she has the invention and becomes disabled.
[0039] For sake of simplicity, it will be assumed that disability
for participants in situations c) and d) occurs at the beginning
of the year in which they achieve age 40. It will also be assumed
that all four participants are contributing $4500 per year to the
plan and that all began contributing at the beginning of the year
in which they achieve age 35. All participants make 24 payroll deposits
to the plan each year and earn a 9% annual investment return. The
premium for the insurance is $45 per year per participant and it
is paid out of each participant's annual contributions beginning
at age 36. Insurance benefits for the participant in situation d)
are paid to the plan monthly after a 365 elimination period. Premium
is waived at the point in which benefit payments begin. TABLE-US-00002
Never Disabled Disabled at Age 40 Age Not Insured Insured Not Insured
Insured 35 $4,699.51 $4,699.51 $4,699.51 $4,699.51 45 $82,524.70
$81,779.49 $47,168.75 $82,079.59 50 $266,756.24 $264,255.84 $111,665.58
$265,572.31 65 $702,929.61 $696,243.73 $264,353.03 $699,966.33
[0040] The financial loss to the individuals who become disabled
is significant and the effect of the invention in mitigating this
loss is apparent.
Invention Solves the "Anti-Linking" Problem
[0041] Tax law states that no other employee benefit program may
have benefits based on the employee's deferral election under the
401(k) plan. To do so would disqualify the "elective"
nature of these contributions. By structuring the insurance as a
feature of the plan, the amount of insurance coverage available
to each insured may be exactly equal to his/her level of elective
contributions in the 401(k) plan. This allows each person's exact
loss to be insured, and it is consistent with the nature of a 401(k)
plan that allows each employee to invest according to his/her individual
retirement goals.
Invention Solves the "Over Insurance" Problem
[0042] By paying disability benefits to the plan for the benefit
of the disabled employee, the concern of "over-insurance"
is mitigated. Because the benefit is not paid as cash to the disabled
employee, there will not be a significant impact on the employee's
motivation toward rehabilitation. The insurer may require that the
plan propose additional withdrawal restrictions on plan assets that
are the result of disability benefits, such as excluding these assets
from hardship withdrawals and loans, or restricting distribution
of these assets during the period of disability. Further, the insurance
contract could specify that disability benefits will cease if insurance
proceeds are withdrawn from the plan.
Invention Solves the "Saved for Retirement" Problem
[0043] The safeguards that may apply to the over-insurance problem
as described above will also solve another problem presented by
the "outside the plan" arrangements. Under an arrangement
where the disabled employee has control of the disability benefits,
there is a risk that the benefits may not be saved for retirement
as intended. By depositing the benefits to the plan and implementing
the restrictions described above, the employer is assured that the
benefits will be treated as plan assets, with even more stringent
restrictions during the period of disability.
Invention Solves the IRC Section 415(c) Problem
[0044] IRC Section 415(c) limits the maximum "annual additions"
to most retirement plans for an individual to 25% of covered compensation.
Ordinarily, since the disabled employee's covered compensation is
zero, any contribution to the plan would be in excess of these limits.
The invention solves this problem by treating the insurance as an
investment of the plan so that benefits paid to the plan may be
considered investment returns rather than contributions. Investment
returns are not included as "annual additions" under 415(c).
Invention Solves the IRC Section 401(k) and 401(m) Testing Problems
[0045] Both of the problems discussed earlier with regard to continuing
contributions into the 401(k) plan for disabled HCEs are the result
of testing those contributions under the 401(k) and (m) rules that
describe the parameters for contributions on behalf of HCEs. Once
again, the invention avoids this problem by treating the insurance
as an investment of the plan so that benefits paid to the plan may
be considered investment returns rather than contributions. If benefits
paid on behalf of a disabled HCE are investment returns rather than
contributions, they are not subject to the non-discrimination requirements
or the tests prescribed in IRC Section 401(k)/(m).
[0046] In addition, the invention provides a way to establish that
the coverage amount is non-discriminatory because it is linked to
contributions that must be demonstrated as non-discriminatory under
401(k)/(m). In addition, contributions made by the employer or employee
to pay the premium would be included in these tests as described
below.
Invention Solves the Complications to the Regular LTD Plan
[0047] Under the invention, the retirement plan disability insurance
is provided by a free standing insurance contract that does not
complicate the regular group LTD plan. The employer is free to structure
the regular LTD program to exclude part-time employees (even if
they are included in the retirement plan) and provide a tax-free
benefit (if desired by the employer and/or employee) without regard
to the retirement plan. However, since the retirement plan disability
insurance is also provided by a group LTD contract, experience under
this contract may influence experience ratings under the regular
LTD contract. This result is unlikely since the elimination period
under this contract is probably longer than the elimination period
under the regular LTD contract.
Invention Solves the "Benefit Guarantee" Problem
[0048] Under the invention, the insurance benefits are provided
through the purchase of a contract from an insurance company, and
therefore, are secured by the financial backing of the insurer.
Continuation of benefits is set by the terms of the contract, not
upon the employer's financial solvency or good will.
Invention Facilitates Compliance Testing
[0049] The following tests must be applied to determine that the
insurance offered within the plan meets the non-discrimination requirements
of a retirement plan.
[0050] 1. IRC Section 415(c) Testing. If the premium for the insurance
is being paid from contributions, whether from a special "premium
designated" employer contribution or from the regular contributions,
the premium for insurance coverage for the current policy year is
included in the prior plan year's "annual additions" of
IRC Section 415(c). The 25% of covered compensation maximum would
include any premiums paid for the following year. As discussed earlier,
disability benefits deposited to the trust are not included as annual
additions.
[0051] 2. IRC Section 401(k) and (m) Testing. If the premium for
the insurance is being paid from contributions, whether from a special
"premium designated" employer contribution or from the
regular contributions, the premiums for coverage in force the current
policy year are included in the prior plan year's contributions
under any applicable non-discrimination tests of IRC Section 401(k)
and (m). If a special "premium designated" employer contribution
is allocated differently the regular employer matching contribution
or if there is no regular employer matching contribution, the premium
contribution would need to be tested separately under IRC Section
401(m) for the prior plan year. This is probable because the premium
contribution would most likely be made for employees still employed
on the last day of the prior plan year and most regular matching
contributions are made for all employees who elect deferrals during
the year.
[0052] 3. IRC Section 410(b) Testing. The "current availability"
portion of the benefits, rights, and features test applicable to
the disability insurance coverage as a benefit of the plan is passed
by applying the 410(b) classification test to the group of participants
for whom coverage entitlement is earned in the prior plan year.
The classification test is applied without average benefit testing,
although the lower threshold set forth in the average benefit test
may be used for the classification test. In addition, the benefits,
rights and features test applicable to an employer "premium
contribution" (whether matching or non-matching) should the
employer choose to make such a contribution is passed by applying
the same 410(b) classification test to those receiving the contribution
for the prior plan year.
[0053] The amount of insurance coverage provided to eligible employees
is demonstrated to be non-discriminatory because it is linked to
contributions which are already demonstrated to be non-discriminatory
by the 401(k) and (m) tests.
[0054] 4. Incidental Benefit Limit. The incidental benefit test
limiting premium for "incidental health and welfare benefits"
to 25% of the employee's annual contribution is applied assuming
that the entire premium contribution is deemed as being made at
the end of the prior plan year, even if the contribution is accrued
for the prior plan year and deposited to the trust the following
plan year. This is important for employers making a special premium
contribution for the prior plan year at the beginning of the current
policy year, even though the employer may choose to deposit the
balance of the contribution to the trust at a later time, as allowed
by tax laws. Premium for the disability insurance is commingled
with applicable premium for life insurance held by the plan.
Invention Can be Applied to Other Defined Contribution Plans
[0055] Defined contribution plans that include non-401(k) employee
deferrals or employee contributions, such as government sponsored
deferred compensation arrangements under IRC Section 457 or plans
sponsored by churches under IRC Section 403(b)(9) may also use the
invention to insure contributions in the event of a participant's
disability.
[0056] Defined contribution plans under IRC Section 401(a) that
include employer contributions based on a percentage of compensation
for each eligible participant rather than on the election of the
participant (such as profit sharing or money purchase pension contributions)
may also employ the methodology.
[0057] Thus, it is an object of the present invention to provide
a method and system for preventing loss of contributions to a retirement
plan during an employee's disability.
[0058] It is a further object of the present invention to provide
a method and system for insuring against loss of retirement benefits
during disability, without violating tax law restrictions against
linking other benefit programs to an employee's deferral election.
[0059] Yet another object of this invention is to provide insurance
against loss of retirement contributions during disability which
does not result in a significant impact on an employee's motivation
toward rehabilitation.
[0060] Yet a further object of the present invention is to provide
insurance against loss of retirement contributions during disability
through a vehicle which minimizes the risk that the benefits may
not be saved for retirement, as intended.
[0061] Still a further object of the present invention is to provide
means for insuring against loss of retirement benefits during disability,
wherein benefits paid to the plan may be considered investment returns,
rather than contributions, thus complying with maximum annual addition
limitations under IRC Section 415(c).
[0062] Another object of the present invention is to provide insurance
against loss of retirement contributions during disability which
is not subject to the non-discrimination requirements or the tests
prescribed in IRC Section 401(k)/(m).
[0063] And it is also an object of the present invention to provide
a method and system for insuring against loss of retirement benefits
during disability which does not complicate an employer's regular
group LTD plan.
[0064] Still further objects of the inventive system and method
disclosed herein will be apparent from the drawing figures and following
detailed description thereof.
BRIEF DESCRIPTION OF THE DRAWINGS
[0065] FIG. 1 is a procedural flow chart illustrating how the record
keeping software and disability application work together to share
information.
[0066] FIG. 2 is a flow chart showing the timing of the data exchange
between the record keeping system and the disability software.
[0067] FIG. 3 is a flow chart showing the logical steps carried
out by the disability application to determine eligibility, to calculate
premiums and to export the transaction information to the record
keeping system.
[0068] FIG. 4 is a step-wise textual flow chart setting forth the
same procedure as is illustrated by FIG. 3.
DESCRIPTION OF THE PREFERRED EMBODIMENT
[0069] The invention includes: 1) the identification of two basic
principles that solve the problems inherent in any of the other
arrangements; and 2) a methodology for applying these two principles
to the administration of the retirement plan.
Principle 1: Insurance is Included as a Provision of the Retirement
Plan
[0070] Disability insurance covering plan contributions must be
included as a plan feature in the retirement plan document and the
conditions for receiving disability coverage must be set forth in
both the plan document and the Summary Plan Description (SPD). Because
it is a feature of the plan, the policy is held by the plan as an
investment of the trust, plan assets are used to pay premiums, and
benefits payable under the policy are paid to the plan rather than
the disabled individual.
Principle 2: Insurance for the Current Year Depends on the Prior
Plan Year
[0071] If the insurance policy is a "feature" of the
retirement plan as described under the first principle, it becomes
subject to all of the compliance requirements of the plan. Therefore,
IRS Section 410(b) that describes non-discrimination for all "benefits,
rights, and features" of the plan would apply. Conservative
practice dictates that the insurance must be non-discriminatory
with regard to availability and with regard to the amount of coverage.
The invention provides a way to define the insurance availability
and coverage amount in a manner that may be demonstrated as non-discriminatory
under Section 410(b). Without this conclusive testing being applied
before the payment of premium, or worse yet, the payment of benefits,
the insurance could be found to be discriminatory in operation,
with serious consequences to the plan.
[0072] The second principle of the invention is that the insurance
is a feature of the retirement plan for the plan year before the
policy year for which the coverage is in force. In other words,
the entitlement to the coverage is earned by participants in the
retirement plan the prior year and the plan feature providing the
disability insurance coverage applies to the prior plan year, but
the actual insurance is in force for disabilities occurring the
next policy year. The results of this prior plan year/current policy
year relationship are: [0073] 1. The amount of coverage for the
current policy year is equal to insured plan contributions for the
prior plan year. [0074] 2. The eligible group for the current policy
year is determined by plan participation in the prior plan year.
[0075] 3. Premiums for the current policy year are paid from the
prior plan year's contributions and/or earnings. [0076] 4. The insurance
is tested under the tax rules for non-discrimination in the prior
plan year.
[0077] This allows the amount of insurance coverage for each participant
to be related both to a fixed compensation amount (to satisfy insurance
company underwriting requirements and plan administration procedures)
and to contributions (to satisfy non-discrimination rules).
EXAMPLE
[0078] An employer who has a 401(k) plan with a calendar plan year
amends the plan on Nov. 30, 1998 to include disability insurance
covering employee deferrals and the employer matching contributions
for 1998. In addition, the employer chooses to make a special matching
contribution to the plan to pay the premium. Therefore, the insureds
are employees who had employee deferrals and employer matching contributions
made to the 401(k) plan on their behalf for the 1998 plan year.
The amount of coverage is equal to the amount of employee deferral
and employer matching contributions for 1998 (excluding the special
"premium" match), and the premium contribution is deposited
to the plan as a 1998 contribution. The insurance is tested for
non-discrimination with regard to the "benefits, rights, and
features" test for 1998, and the special matching contribution
is tested under IRC Section 401(m) for 1998. The effective date
of the insurance would be Jan. 1, 1999 and the policy would provide
insurance for disabilities occurring in 1999.
ALTERNATIVE EMBODIMENTS OF THE INVENTION
[0079] Several existing software, whether manufactured by a software
company or created by the user for the purpose of record keeping
a Defined Contribution Plan, track assets in the trust on a participant
by participant level and store the data required under applicable
tax laws. All assets in the trust are accounted for via a matrix
that tracks "sources," or types of money, that are deposited
into the trust (i.e., employee pre-tax deferral contributions, employer
matching contributions, employer profit sharing contributions, rollover
contributions, etc.) and "funds," or investment options,
within the trust (securities or investments in which trust assets
are invested). Contributions, investment earnings, fees, loans,
withdrawals, and other account activity are identified with both
the correct source and fund within each participant's account.
[0080] The preferred embodiment of the invention would be a separate
computerized software program, or "disability application,"
to collect the required data from the record keeping system to calculate
premiums for each eligible participant and create the transaction
instruction for the record keeping system to initiate the payment
of the premium from each participant's account. The disability application
provides current coverage and premium data for both the record keeping
system and the insurer and archives historical participation data
in the disability policy for use by the insurer to monitor coverage
in force and adjudicate future disability claims. The disability
application also provides data on the disability policy for the
record keeping system to include in preparing the necessary compliance
tests for the plan.
[0081] Another satisfactory method of applying the invention is
to incorporate the processes and calculations of the methodology
within the record keeping software itself and avoid the need for
interface between the two systems. In either approach, the computerized
processes covered by the invention remain the same.
Insurance Contract Provisions
[0082] Applying the methodology to the underlying group long-term
disability insurance policy requires certain unique provisions in
the insurance contract. The insurance contract must contain the
following provisions: [0083] 1. The policyholder is the trustee
of the insured plan. [0084] 2. The policy year of the insurance
contract is matched to the plan year of the plan (i.e. January 1-December
31, etc). [0085] 3. The insured for the policy year are employees
who had an insured contribution made to the plan on their behalf
for the prior plan year. [0086] 4. The amount of monthly benefit
for each insured is equal to 1/12th of the amount of insured contributions
for the prior plan year. [0087] 5. The premium for the current year
is paid by the trustee from the prior year's contributions or investment
earnings. [0088] 6. The elimination period between the occurrence
of the disability and the commencement of benefits is at least 365
days. [0089] 7. The policy provides for benefits to be paid to the
plan in the event of an insured's long-term disability. [0090] 8.
Disability benefits will cease if they are withdrawn from the plan
during the disability period. Methodology of the Invention
[0091] The following functions, processes, and calculations are
necessary to apply the basic principles of the invention to plan
administration processes.
I. Underwriting/Renewal Process
[0092] Process 1--Collect "employee indicative data"
from record keeping system the appropriate participant-level data
fields required by the insurer to provide initial or renewal premium
rates: [0093] Participant/record identifier (i.e., SSN) [0094] Gender
[0095] Occupation Code [0096] Date of Birth [0097] Date of Hire
[0098] YTD compensation (W-2 pay from plan entry date, [ok if capped
at $160,000]) [0099] YTD contributions (by source for insured sources
only)
[0100] This information is provided annually based on the YTD information
for the current plan year for the insurer to provide rates for the
following policy year. If the YTD data to be provided includes less
than six plan months of data, the current year information will
not be sufficient. In those cases, the complete annual information
from the plan year prior to the year in which the file is being
prepared will be used. [0101] Process 2--Prepare file with renewal
data and send to the insurer. II. Annual Eligibility Determination
[0102] Process 1--Collect data from record keeping system necessary
to identify employee participants meeting the definition of eligibility
for the new policy year under the insurance contract and to determine
coverage in force based on the prior plan year's insured contributions,
then assign or maintain the existing Effective Date of insurance
for each.
[0103] Requirements to be in Eligibility Group: [0104] 1. Contribution
made for an Insured Source in the Plan Year prior to the Policy
Year; and [0105] 2. No Date of Termination prior to the last day
of the prior Plan Year. [0106] Process 2--Calculate annual and monthly
premium for each eligible participant for appropriate coverage in
force using the rate provided by the insurer and send file with
annual amount back to record keeping system. [0107] Process 3--Expand
record keeping matrix to include "Beneficiary Payments"
as a source of money and "Insurance Premium Fund" as an
investment fund offered by the Plan. [0108] Process 4--Transfer
assets from the other funds to the Insurance Premium Fund in the
amount necessary to pay the full year's premium on the first day
of the new policy year for all eligible participants. Assets to
pay the premium may be taken from any of the prior year's contribution
sources (employee deferral, employer match, etc.), from the prior
year's investment earnings, or a combination of both. As an alternative,
the employer may make a special contribution to the plan to cover
the premium. This contribution would be deposited directly to the
Insurance Premium Fund as a new money source for the prior year.
III. Monthly Premium Transactions [0109] Process 1--At each premium
due date, collect updated participant information (specifically,
date of termination and beneficiary payment status) from the record
keeping system to determine eligible participants for whom premiums
are due. Premiums are paid for all identified in the annual Eligibility
Group, except those with a Date of Termination on or before the
last day of the prior month, and those who received a Disability
Benefit from this policy in the prior month. [0110] Process 2--Prepare
a transaction file for the record keeping system to deduct appropriate
premium amounts from participant accounts and instruct the trustee
to forward payment to the insurer. [0111] Process 3--Produce a report
for the insurer of total covered lives, total insurance in force,
and total premiums for the premium due date. IV. Retroactive Premium
Adjustments [0112] Process 1--If at any time during the policy year
the amounts of contributions for the prior plan year are adjusted
due to errors in accounting, or adjustments are required to pass
compliance tests (i.e., recharacterization of contributions, refunds
of contributions, employer corrective contributions are made for
the plan year), the corrected contribution amounts are collected
from the record keeping system and sent to the disability system
and a corrected coverage in force is determined for affected participants.
[0113] Process 2--Recalculate the annual premium amount for the
entire policy year using the corrected coverage in force. If premiums
to date have been overpaid for affected individuals, the overpayment
is credited against future premiums due for the individual. If premiums
to date have been underpaid for affected individuals, the underpayment
is included in future premiums due for the individual. If the participant
has already terminated, no adjustment is made. V. Beneficiary Payment
Deposits [0114] Process 1--Deposit beneficiary payments received
by the trust from the insurer to the Beneficiary Payment source
of money in the record keeping matrix for the disabled participant
and flag such payments as withdrawal restricted while benefits are
being paid to the trust on behalf of the disabled participant. [0115]
Process 2--Identify and notify the insurer of any disabled participant
taking a withdrawal of beneficiary payments made to the plan while
in beneficiary payment status. VI. Annual Reporting/Archiving [0116]
Process 1--Prepare a report for each employee participant of the
amount of coverage in force and the amount of premium paid during
the current policy year. [0117] Process 2--Produce reports for the
insurer of total covered lives, total insurance in force, and total
premiums paid for the policy year. [0118] Process 3--Archive the
annual participation data, including specific participants for the
policy year, effective dates of coverage, amount of coverage in
force, and total premiums paid by participant and maintain policy
records for inspection by the insurer for a period of seven years.
[0119] Process 4--Verify effective date, premiums paid, and coverage
in force for the insurer in the event of a disability claim made
by an insured. VII. Annual Compliance Testing/Reporting [0120] Process
1--Provide data to include premiums paid from contributions for
coverage in force the current policy year in applicable testing
for the prior plan year under 415(c). Adjust contributions and premiums
as necessary to pass tests. Exclude amounts deposited during the
prior plan year as beneficiary payments. [0121] Process 2--Provide
data to include premiums paid from contributions for coverage in
force the current policy year under applicable testing for 401(k)
and/or (m) for the prior plan year. If the employer made a matching
premium contribution for the prior plan year for the exact group
of participants receiving the regular matching contribution, include
the matching premium contribution in the applicable 401(k) and/or
(m) tests. Exclude amounts deposited during the prior plan year
as beneficiary payments. [0122] Process 3--If the employer made
a matching premium contribution for the prior plan year and the
regular matching contribution does not have a last day of plan year
requirement, the application must provide data for a special 401(k)
and/or (m) test on the matching premium contribution for the prior
plan year. [0123] Process 4--Provide data for a 410(b) classification
test using the lower threshold of the average benefit test on the
group of participants who earned entitlement to the insurance in
the prior plan year (generally will include all participants contributing
during the year and who were still employed on the last day of the
plan year). [0124] Process 5--Provide data for a 410(b) classification
test if any employer premium contribution was made for the prior
plan year, using only those who received the contribution for the
prior plan year (may include all participants still employed on
the last day of the plan year or may include only participants contributing
during the year and still employed on the last day of the plan year).
[0125] Process 6--Provide data for the incidental benefit test limiting
insurance premiums to 25% of annual contributions using total annual
premium for each individual (must combine with any applicable life
insurance premiums paid by the plan). [0126] Process 7--Provide
data required for preparation of tax reporting forms 1099 or W-2
in the case that premiums paid for the insurance are taxable, or
that beneficiary payments withdrawn from the plan by the employee
participant are taxable. Data Sources
[0127] The disability application will receive data from: [0128]
1. An automatic import from the record keeping system. [0129] 2.
Manual file load from employer's HRIS records. [0130] 3. Manual
input of insurance rates from insurer, disability payment status,
disability payment amount, etc. Database Elements
[0131] The disability application will require new database elements
within the record keeping system at the System Level, the Plan Level,
and the Participant Level.
[0132] System Level Information
[0133] Disability premium transaction code
[0134] Disability benefit payment transaction code
[0135] Plan Level Information
[0136] Additional fund--Disability Premiums
[0137] Additional source of money--Disability Benefits
[0138] Source flag for all sources--Contribution Eligible for Disability
Insurance
[0139] Flag for Disability Source--Exclude Source from Compliance
testing
[0140] Annual Effective Date
[0141] Current Effective Date
[0142] Disability Premium Rate
[0143] Coverage Percentage--percent of Eligible Contribution to
be insured
[0144] Voluntary--Y or N whether Disability Insurance is elective
[0145] Premium Source Flag--which Source Premiums are paid from
[0146] Participant Level Information
[0147] (* Indicates data elements already held within record keeping
system. All other data elements are new.)
[0148] *Social Security Number
[0149] *Name
[0150] *Address
[0151] *City State Zip
[0152] *Date of Birth
[0153] *Date of Hire/Rehire
[0154] *Date of Termination
[0155] Sex
[0156] Occupation Code
[0157] Election to Participate Flag
[0158] Coverage Effective Date
[0159] Disability Date
[0160] Disability Payment Start Date
[0161] Disability Benefit Status
[0162] Annual Coverage Amounts (by Source)
[0163] Annual Premium Amounts (by Source)
[0164] Life-to-Date Coverage Amounts (By Source)
Note: Year-To-Date and Life-To-Date premium and payment information
should be accessible via transaction detail reporting within the
record keeping system.
Menu Structure
[0165] The menu structure will require items on both the record
keeping side and the disability application side. They are as follows:
Record Keeping System Menu Elements
[0166] 1. Export Annual Disability File
[0167] 2. Import Premium File
[0168] 3. Process Annual Premium Transfers
[0169] 4. Process Monthly Premiums
[0170] 5. Process Monthly Disability Payments
Disability Application Menu Elements
[0171] 1. Import Annual Disability File
[0172] 2. Calculate Annual Coverage/Premiums
[0173] 3. Export Premium File
[0174] 4. Year-End Archive
[0175] 5. Reporting
Flowcharts and Diagrams
FIG. 1--Disability Compensation Plan Procedural Flowchart
[0176] This figure details how the record keeping software and
disability application work together to share information. The participant
level data necessary for processing the insurance initially resides
within the record keeping system. The disability application would
provide the necessary administration functions and send the transaction
information back to the record keeping system. This figure illustrates
the functions provided by the disability software, which include
calculation of the premium amounts, creating transaction records
for the record keeping system, and providing data archive.
FIG. 2--Disability Compensation Plan Possible Monthly Workflow
[0177] This figure illustrates the timing of the data exchange
between the record keeping system and the disability software in
order to administer the insurance.
FIG. 3--Disability Compensation Plan Premium Calculation Procedures
[0178] FIG. 3 illustrates the logical procedures the disability
application undertakes in order to determine eligibility for insurance,
calculate the premiums and return the transaction information to
the record keeping system.
FIG. 4--Technical Description of Disability Compensation Plan Processes
[0179] FIG. 4 illustrates the same procedure for determining eligibility,
calculating premiums as FIG. 3 but in the form of text.
Variations of the Methodology
Premiums Paid as Plan Expense
[0180] Defined Contribution Plans are allowed under regulations
provided by the IRS and the Department of Labor (DOL) to pay certain
plan expenses from plan assets. Plan expenses must be related directly
to the administration of the plan itself. Generally, such expenses
are netted out of investment earnings and are not itemized on the
participant statements. Plan expenses in total are included on the
annual reporting Form 5500 and are given to participants in the
Summary Annual Report.
[0181] If approved by the IRS and the DOL, disability insurance
as an inherent feature of the plan could be charged against earnings
as a plan expense. The principles of holding the insurance inside
the plan and using the prior plan year as the basis for coverage
in the insurance would remain unchanged. This variation in the methodology
would be as follows: [0182] First--the file described under "Process
I, Underwriting/Renewals Process" would be prepared for the
insurer. Additional data required by the insurer would include the
employer's current and projected turnover ratio. The insurer would
calculate the premium rate and establish the total annual premium
for the plan by projecting total plan year contributions, terminations
through the remainder of the year and terminations for the next
year, and possible adjustments due to discrimination tests, etc.
The annual premium for the plan is fixed, but the number of individuals
and total amount of coverage may change during the plan year due
to terminations, testing, etc. [0183] Second--before the end of
the prior plan year, the trustee instructs the record keeper to
allocate the total annual premium as an "expense" against
earnings for the prior plan year. Record keeping software allows
the user to build in system parameters on how the expense should
be allocated. For this expense, the parameters would be set to allocate
the expense only to participants who are not terminated, who are
not receiving disability benefits, and who are under age 65; then
the allocation would be weighted according to contributions. The
total premium would be subtracted from the plan's final quarter
earnings and moved into a segregated account. The total annual premium
would be sent to the insurer after the effective date of coverage.
This step would replace processes II through IV. [0184] Third--beneficiary
payments for a participant receiving a disability benefit would
be handled exactly as "Process V--Beneficiary Payment Deposits."
[0185] Fourth--"Process VI--Annual Reporting/Archiving"
would not be necessary. If a disability claim is made by a participant,
the insurer would check with the employer to see that the eligibility
requirements under the terms of the policy have been met and to
verify the actual amount of coverage that was in force for the individual
on the date of disability. [0186] Fifth--Steps 4, 6, and 7 would
be the only required processes under "Process VII--Annual Compliance
Testing/Reporting." Individual Disability Policies
[0187] The methodology described herein uses a group long-term
disability policy to provide the insurance. However, if the insurance
is to be offered on a voluntary basis, a group policy may not be
desirable and the methodology may be better applied using individual
policies for the participants in the plan who desire the coverage.
Once again, the principles of holding the insurance inside the plan
and using the prior plan year as the basis for coverage for the
insurance would remain unchanged. The premium for individual policies
would be paid annually for the entire plan year and coverage would
continue throughout the plan year, even if an employee terminates
employment. The modifications to the methodology are as follows:
[0188] First--the underwriting and annual eligibility would be as
described in Processes I and II. [0189] Second--rather than monthly
premium transactions as explained in Process III, the system would
track a "yes" or "no" election for each participant
and would pay the annual premium once at the beginning of the year
for each participant electing "yes" (illustration included
in FIG. 3). In addition, the system would send the entire participant
record to the insurer, who would keep participant specific data
for each policy. [0190] Third--Processes IV, V, VI, and VII would
be as described. Application to Other Defined Contribution Plans
Other Employee Deferrals
[0191] Defined contribution plans that include non-401(k) employee
deferrals or employee contributions, such as government sponsored
deferred compensation arrangements under IRC Section 457 or plans
sponsored by churches under IRC Section 403(b)(9) may also use the
invention to insure contributions in the event of a participant's
disability. Such plans are not subject to all of the tax regulations
and non-discrimination requirements that a 401(k) plan must meet,
however, the invention allows for these plans to provide insurance
in a manner consistent with plan administration requirements and
insurance underwriting requirements, while assuring that insurance
proceeds will be held until retirement.
[0192] Defined contribution plans sponsored by educational or charitable
organizations under IRC Section 403(b)(7) are restricted to investing
in annuities or mutual funds. Should the rules regarding investment
options for these plans be broadened, the invention would also be
useful to such plans, since they are also subject to the non-discrimination
requirements of IRC Section 415(c) and/or the Maximum Exclusion
Allowance and IRC Section 401(m) (for matching contributions).
Other Employer Contributions
[0193] Defined contribution plans under IRC Section 401(a) that
include employer contributions based on a percentage of compensation
for each eligible participant rather than on the election of the
participant (such as profit sharing or money purchase pension contributions)
may also employ the methodology. Because these employer contributions
are not subject to the anti-linking rules or 401(k)/(m) non-discrimination
testing (unless elected by the employer), not all of the presented
arguments for the necessity of the invention apply to these types
of contributions. However, employers often provide employees a defined
contribution program that involves a combination of both 401(k)
employee deferrals and employer contributions, and generally, all
contribution types are administered together as one retirement program.
Therefore, the presented methodology is the only consistent way
to offer disability insurance covering all contribution types. To
employ another methodology to the non-401(k) or non-matching contributions
would be overly confusing to the employees.
[0194] In addition, it would be undesirable for the amount of insurance
coverage and the premium to change as a participant's compensation
changes during the plan year under any type of defined contribution
plan. Because in any qualified defined contribution plan the insurance
amount must be based on a non-discriminatory formula, such as contributions
(which must be demonstrated to be non-discriminatory under plan
rules), using the prior year as the basis for coverage produces
the best result. Such plans also have the option of applying the
methodology using a fixed percentage of the prior year's plan compensation
for each participant as the basis for determining insurance amount
rather than using the prior year's actual contributions. All other
aspects of the methodology would apply as described.
[0195] The foregoing detailed disclosure of the inventive method
and system are considered as only illustrative of the preferred
embodiment of, and not a limitation upon the scope of, the invention.
Those skilled in the art will envision many other possible variations
of the structure disclosed herein that nevertheless fall within
the scope of the following claims.
[0196] And, alternative uses for this inventive method and system
may later be realized. Accordingly, the scope of the invention should
be determined with reference to the appended claims, and not by
the examples which have herein been given.
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