The Death Benefit Only Program

Limitations of the DBO Program

Because this has a death benefit component, there is no maximum limitation of death benefits or asset accumulation. IRC Section 457(f)(2)(iii) (1986). The program provides a current death benefit for covered employees. This is an actuarial-based structure for an employer that maximizes the benefits to the employer while providing a selective benefits program for qualifying employees. This creates a versatile tool that is ideal for Golden Handcuffs, employment contracts, funds to help offset future employer financial' obligations and covenants not to compete. The employer may use this tool in transactions'to reduce the cost of funding employee or share-holder buy outs or future compensation packages. The employer may fund the executive benefit providing the same amount of funding and the selected employees will receive more benefit than the traditional deferred compensation method or the employee will reduce the amount of funding and the selected employees will receive equivalent benefit. The DBO Program also avoids the Golden Parachute limitations and excise tax. Unlike the 457(f) rules, there is no immediate taxation upon termination of risk of forfeiture, and properly designed, income and estate taxes may be totally avoided. Also unlike the traditional benefit plans that have a substantial risk of forfeiture of '457(f), '409A or '83, The DBO Program has no contribution limitation. The arrangement also avoids the risk of forfeiture tests. The benefit program complies with the most recent legislative rules IRC '101(j), COLI Best Practices Act of 2005 and as an exception under '72(k)(2)(B)(ii) and the American Jobs Creation Act of 2004 IRC '409A and Notice 2005-1.

How The DBO Program Works

The DBO Program is based on well-established death benefit, economic benefit and constructive receipt rules successfully utilized since the early 1960s. It complies with all proposed regulatory rules, and the tax shelter rules as presented which further assures positive results. The arrangement is not a tax shelter, a listed transaction or a reportable transaction. The arrangement complies with the economic substance test as proposed in Congress as well as set forth in case law and proposed legislation. The employer's contribution is actuarially determined and that amount is deductible. (Sec. 79, Treas.Reg 1.162.10 TAM 200002047 and 20050204). The employer can utilize a current death benefit arrangement with an employment or non-competition agreement to provide benefits that may reduce income and estate tax to the employee. This arrangement complies with the deferred compensation rules of ' 409A because it is a death benefit plan qualifying under 31.3121(v)(2)-1(b)(4)(iv)(A). The IRS announced in the proposed regulations that Code ' 83 is applicable to an insurance arrangement between an employer and a participant. According to the regulations, not only is the value of current annual life insurance protection (Table I below) includible as taxable compensation to the insured participant each year but, in addition, in line with Rev. Proc. 2003-25 and Section 72, the cash surrender value of the policy would not be subject to income tax nor be a reportable event if the policy is not surrendered. This is further in line with Reg. 105885-99. The flow chart below'demonstrates how The DBO Program works.

Implementing the DBO Program

1. The employer would create or amend its non-tax qualified deferred compensation plan to add a feature pursuant to which all or selected participants would be given an opportunity to elect to relinquish their rights to receive accrued deferred compensation benefits in pre-409A grandfathered account in return for the employer's contribution to The DBO program providing for a current death benefit on the life of the participant (the Policy) co-owned by or the employee or employer depending upon the circumstances.
2. Employees desiring to avail themselves of this opportunity would elect, prior to the time benefits under the deferred compensation plan become payable, to relinquish those benefits and have the employer contribute the cost of such benefits.
3. An employee, his or her assignee, or the employer would apply for, obtain and own a permanent life insurance benefit. The employee or the employer would enter into a co-ownership life insurance agreement providing that the Employer pay for the current death benefit. This is actuarially determined in line with qualified asset account limits. The co-owner (the employee or the employer) would pay for the remainder of the premiums and retain all other rights to the policy.
4. Unless the co owner fails to maintain the policy (see the flow chart on page 7) or breaches certain obligations to the employer, the current death benefit is provided to employees thru the plan so long as the participant is in the plan.
5. Upon an employee participant withdrawing from the plan, or upon plan termination, the co-ownership agreement is terminated, the employer no longer funds the plan and the co-owner retains all right, title and interest in the coverage.

See Table 1'below for an example of implementing The DBO Program.

Conclusion

This approach will comply on both a legal and accounting basis and may be a tremendous economic solution to this funding and compliance situation. In addition, this tool will allow the employer to retain equity within the business and relieve the employees from having to use personal assets to fund current death benefits and financial obligations. See the sidebar, “Planning Opportunity,” below, for a real-life example of The DBO Program.

Planning Opportunity Car Dealer 52 Death Benefit Only Plan

1. Principal (CD52) owns Car Dealership (ER) ' operating company wants to:

• Provide death benefits to employees while employed;
• Comply with '409A and COLI Best Practices;
• Pre-fund for corporate benefits and def comp; and
• Avoid claims of creditors of ER and CD52.

2. ER enters into an agreement to provide death benefits for its employees. Administrative agreement between ER & Advisors, LLC.

3. Advisors LLC annually obtains value of costs of death benefit life segment. An executive carve out plan as allowed under TAM200002047 integrates permanent and current coverage. Valuation is based on death benefits as permitted under '3131.21. Face amount of death benefit for HCE CD52es ($5 MM) not exceed face amount for Rank and file (50RF = $100K GTL). We can have spouse be the employee.

4. ER deducts the amount actuarially determined using the stable value $225K.

5. Bonus out the other $25K to CD52, tax $10K annually. Moves $2.5MM over 10 years. Total tax cost = $100K.

6. Table I tax CD52 $13,524, offset by supplemental funding of $25K + no tax on Table I.

7. GB pulls out $274K annually over 20 yrs. Total = $5.491M tax free.

8. COLI Best Practices are followed because employees name beneficiary as long as employed.

9. '409A and Notice 2005-01 Final 409 A regs TD 9321 exempt death benefit only plans under 31.3121.

10. Asset acts like COLI product for tax advantaged build up and possible tax-free distributions.

[IMGCAP(1)]

[IMGCAP(2)]

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions. He writes articles and speaks nationally about Decision Trees on COLI Best Practices, 409A and Benefit Planning.

The Death Benefit Only (DBO) program provides non-qualified deferred compensation, and death benefits. The DBO program can be used by employers without regard to corporate and qualified plan limitations and may be provided by employers on a permissibly discriminatory basis. The DBO program, when structured properly, can accept elective or non-elective contributions on an individual employee basis. The benefits can also be used as Golden Handcuffs to retain valued employees.

Structure of the DBO Program

The DBO Program' can be applied to an existing deferred compensation plan as well as new wealth accumulation plan. This approach will be flexible to the employer and largely estate- and income-tax free to the covered employee. The accrued benefit to the employee can be safeguarded from claims of creditors of the employer and employees and upon withdrawal by the employee can be accessed in an economically efficient manner. The death benefit need not be an asset on the books of the practice or subject to the claims of creditors. Additionally, the employer can institute The DBO Program as a new benefit plan and fund “as you go” rather than creating a liability for employer needs. The DBO Program alternatively, may be reflected as an asset on the practice's books for audit accounting purposes and not create a charge to earnings. This tool complies with both GAAP accounting as well as IAS 19.

Limitations of the DBO Program

Because this has a death benefit component, there is no maximum limitation of death benefits or asset accumulation. IRC Section 457(f)(2)(iii) (1986). The program provides a current death benefit for covered employees. This is an actuarial-based structure for an employer that maximizes the benefits to the employer while providing a selective benefits program for qualifying employees. This creates a versatile tool that is ideal for Golden Handcuffs, employment contracts, funds to help offset future employer financial' obligations and covenants not to compete. The employer may use this tool in transactions'to reduce the cost of funding employee or share-holder buy outs or future compensation packages. The employer may fund the executive benefit providing the same amount of funding and the selected employees will receive more benefit than the traditional deferred compensation method or the employee will reduce the amount of funding and the selected employees will receive equivalent benefit. The DBO Program also avoids the Golden Parachute limitations and excise tax. Unlike the 457(f) rules, there is no immediate taxation upon termination of risk of forfeiture, and properly designed, income and estate taxes may be totally avoided. Also unlike the traditional benefit plans that have a substantial risk of forfeiture of '457(f), '409A or '83, The DBO Program has no contribution limitation. The arrangement also avoids the risk of forfeiture tests. The benefit program complies with the most recent legislative rules IRC '101(j), COLI Best Practices Act of 2005 and as an exception under '72(k)(2)(B)(ii) and the American Jobs Creation Act of 2004 IRC '409A and Notice 2005-1.

How The DBO Program Works

The DBO Program is based on well-established death benefit, economic benefit and constructive receipt rules successfully utilized since the early 1960s. It complies with all proposed regulatory rules, and the tax shelter rules as presented which further assures positive results. The arrangement is not a tax shelter, a listed transaction or a reportable transaction. The arrangement complies with the economic substance test as proposed in Congress as well as set forth in case law and proposed legislation. The employer's contribution is actuarially determined and that amount is deductible. (Sec. 79, Treas.Reg 1.162.10 TAM 200002047 and 20050204). The employer can utilize a current death benefit arrangement with an employment or non-competition agreement to provide benefits that may reduce income and estate tax to the employee. This arrangement complies with the deferred compensation rules of ' 409A because it is a death benefit plan qualifying under 31.3121(v)(2)-1(b)(4)(iv)(A). The IRS announced in the proposed regulations that Code ' 83 is applicable to an insurance arrangement between an employer and a participant. According to the regulations, not only is the value of current annual life insurance protection (Table I below) includible as taxable compensation to the insured participant each year but, in addition, in line with Rev. Proc. 2003-25 and Section 72, the cash surrender value of the policy would not be subject to income tax nor be a reportable event if the policy is not surrendered. This is further in line with Reg. 105885-99. The flow chart below'demonstrates how The DBO Program works.

Implementing the DBO Program

1. The employer would create or amend its non-tax qualified deferred compensation plan to add a feature pursuant to which all or selected participants would be given an opportunity to elect to relinquish their rights to receive accrued deferred compensation benefits in pre-409A grandfathered account in return for the employer's contribution to The DBO program providing for a current death benefit on the life of the participant (the Policy) co-owned by or the employee or employer depending upon the circumstances.
2. Employees desiring to avail themselves of this opportunity would elect, prior to the time benefits under the deferred compensation plan become payable, to relinquish those benefits and have the employer contribute the cost of such benefits.
3. An employee, his or her assignee, or the employer would apply for, obtain and own a permanent life insurance benefit. The employee or the employer would enter into a co-ownership life insurance agreement providing that the Employer pay for the current death benefit. This is actuarially determined in line with qualified asset account limits. The co-owner (the employee or the employer) would pay for the remainder of the premiums and retain all other rights to the policy.
4. Unless the co owner fails to maintain the policy (see the flow chart on page 7) or breaches certain obligations to the employer, the current death benefit is provided to employees thru the plan so long as the participant is in the plan.
5. Upon an employee participant withdrawing from the plan, or upon plan termination, the co-ownership agreement is terminated, the employer no longer funds the plan and the co-owner retains all right, title and interest in the coverage.

See Table 1'below for an example of implementing The DBO Program.

Conclusion

This approach will comply on both a legal and accounting basis and may be a tremendous economic solution to this funding and compliance situation. In addition, this tool will allow the employer to retain equity within the business and relieve the employees from having to use personal assets to fund current death benefits and financial obligations. See the sidebar, “Planning Opportunity,” below, for a real-life example of The DBO Program.

Planning Opportunity Car Dealer 52 Death Benefit Only Plan

1. Principal (CD52) owns Car Dealership (ER) ' operating company wants to:

• Provide death benefits to employees while employed;
• Comply with '409A and COLI Best Practices;
• Pre-fund for corporate benefits and def comp; and
• Avoid claims of creditors of ER and CD52.

2. ER enters into an agreement to provide death benefits for its employees. Administrative agreement between ER & Advisors, LLC.

3. Advisors LLC annually obtains value of costs of death benefit life segment. An executive carve out plan as allowed under TAM200002047 integrates permanent and current coverage. Valuation is based on death benefits as permitted under '3131.21. Face amount of death benefit for HCE CD52es ($5 MM) not exceed face amount for Rank and file (50RF = $100K GTL). We can have spouse be the employee.

4. ER deducts the amount actuarially determined using the stable value $225K.

5. Bonus out the other $25K to CD52, tax $10K annually. Moves $2.5MM over 10 years. Total tax cost = $100K.

6. Table I tax CD52 $13,524, offset by supplemental funding of $25K + no tax on Table I.

7. GB pulls out $274K annually over 20 yrs. Total = $5.491M tax free.

8. COLI Best Practices are followed because employees name beneficiary as long as employed.

9. '409A and Notice 2005-01 Final 409 A regs TD 9321 exempt death benefit only plans under 31.3121.

10. Asset acts like COLI product for tax advantaged build up and possible tax-free distributions.

[IMGCAP(1)]

[IMGCAP(2)]

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions. He writes articles and speaks nationally about Decision Trees on COLI Best Practices, 409A and Benefit Planning.