Popular so-called “419 Insurance Welfare Benefit Plans”, sold by most insurance professionals, are getting accountants and their clients into more and more trouble. A CPA who is approached by a client about one of the abusive arrangements and/or situations to be described and discussed in this article must exercise the utmost degree of caution, not only on behalf of the client, but for his/her own good as well. The penalties noted in this article can also be applied to practitioners who prepare and/or sign returns that fail to properly disclose listed transactions, including those discussed herein.
On October 17, 2007, the IRS issued Notice 2007-83, Notice 2007-84, and Revenue Ruling 2007-65. Notice 2007-83 essentially lists the characteristics of welfare benefit plans that the Service regards as listed transactions. Put simply, to be a listed transaction, a plan cannot rely on the union exception set forth in IRC Section 419A(f)(5),there must be cash value life insurance within the plan and excessive tax deductions for life insurance, in excess of what may be permitted by Sections 419 and 419A, must have been claimed.
In Notice 2007-84, the Service expressed concern with plans that provide all or a substantial portion of benefits to owners and/or key and highly compensated employees. The notice identified numerous specific concerns, among them:
1. The granting of loans to participants
2. Providing deferred compensation
3. Plan terminations that result in the distribution of assets rather than being used post-
retirement, as originally established.
4. Permitting the transfer of life insurance policies to participants.
Alternative tax treatment may well be in the offing for such arrangements, as the IRS intends to re-characterize such arrangements as dividends, non-qualified deferred compensation (under IRC Section 404(a)(5) or Section 409A), split-dollar life insurance arrangements, or disqualified benefits pursuant to Section 4976. Taxpayers participating in these listed transactions should have, in most cases, already disclosed such participation to the Service. Those who have not should do so at the earliest possible moment. Failure to disclose can result in severe penalties – up to $100,000 for
individuals and $200,000 for corporations.
Finally, Revenue Ruling 2007-65 focused on situations where cash value life insurance is purchased on owner employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419A (f)(6), and 419 plans. Life insurance premiums are not inherently tax deductible and authority must be found in Section 79 to justify such a deduction. Section 264(a), in fact, specifically disallows tax deductions for life insurance, at least in some cases. And moreover, the Service declared, interposition of a trust does not change the nature of the transaction.
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He speaks at more than 70 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.taxadvisorexperts.org or call 516-938-5007.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Showing posts with label annuities and life insurance. Show all posts
Showing posts with label annuities and life insurance. Show all posts
Captive Insurance and Other Tax Reduction Strategies – The Good, Bad, and Ugly
By Lance Wallach May 14th
Every accountant knows that increased cash flow and cost savings are critical for businesses. What is uncertain is the best path to recommend to garner these benefits.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance Plans These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance Plans These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive insurance products do have statutory protection for deducting life insurance premiums (although not 831(b) captives). Learning what works and is safe is the first step an accountant should take in helping his or her clients use these powerful, but highly technical insurance tools.
Lance Wallach speaks and writes extensively about VEBAs, retirement plans, and tax reduction strategies. He speaks at more than 70 conventions annually, writes for 50 publications, and was the National Society of Accountants Speaker of the Year. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
The Team Approach to Tax, Financial and Estate Planning
by Lance Wallach
CPAs are the best and most qualified professionals when it comes to serving their clients needs, but they need to know when and how to coordinate with other experts.
Over the last twenty years we have worked with thousands of practitioners who have decided to add financial services to their practices. They do it for a variety of reasons, but the most common are as follows:
*They don’t want to refer their client elsewhere when they request financial services.
* They want to remain competitive.
*They want to diversify and increase their revenue as opposed to depending solely on tax and accounting revenue.
While helping these professionals add planning and investment services to their core offerings, we have found that they achieve four main benefits after doing so:
1. They are more satisfied with their work.
2. Their clients are more satisfied because they can work with someone they trust to meet financial goals.
3. Their clients give them more referrals.
4. Their incomes increase.
We believe that CPAs are the most appropriate--and perhaps the only--professionals who can provide comprehensive financial services to clients because they understand their clients' tax and financial situations. Their clients trust these practitioners to provide professional advice that is in their best interest. In fact, we believe that tax professionals have an obligation and responsibility to advise their clients, and clients expect their professionals to advise them in these important areas.
With a combination of never-ending tax reform, the Tax Code's significant and complex changes, and the market volatility we've experienced over the past few years, clients need guidance more than ever. Practitioners who provide financial planning and investment advisory services are in a position to advise and assist their clients with these issues.
Practitioners just starting out in this arena may not possess the myriad skill sets and substantive knowledge required to embark on new business ventures.
CPAs who don't have all of the necessary talent in-house may find it easier to associate themselves with strategic "partners" who can provide the proper skill sets, training, technology, support and turnkey solutions in their specialized disciplines and niches, to help identify and meet their clients' financial goals.
Adapted from "The Team Approach to Tax, Financial & Estate Planning," edited by Lance Wallach, with chapters by Katharine Gratwick Baker, Fredda Herz Brown, Dr. Stanly J. Feldman, Ira Kaplan, Joseph W. Maczuga, Roger E. Nauheimer, Roger C. Ochs, Matthew J. O'Connor, Richard Preston, Steve Riley, Carl Lloyd Sheeler, Peter Spero, Paul J. Williams, and Roger M. Winsby. Product 017235.
Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
CPAs are the best and most qualified professionals when it comes to serving their clients needs, but they need to know when and how to coordinate with other experts.
Over the last twenty years we have worked with thousands of practitioners who have decided to add financial services to their practices. They do it for a variety of reasons, but the most common are as follows:
*They don’t want to refer their client elsewhere when they request financial services.
* They want to remain competitive.
*They want to diversify and increase their revenue as opposed to depending solely on tax and accounting revenue.
While helping these professionals add planning and investment services to their core offerings, we have found that they achieve four main benefits after doing so:
1. They are more satisfied with their work.
2. Their clients are more satisfied because they can work with someone they trust to meet financial goals.
3. Their clients give them more referrals.
4. Their incomes increase.
We believe that CPAs are the most appropriate--and perhaps the only--professionals who can provide comprehensive financial services to clients because they understand their clients' tax and financial situations. Their clients trust these practitioners to provide professional advice that is in their best interest. In fact, we believe that tax professionals have an obligation and responsibility to advise their clients, and clients expect their professionals to advise them in these important areas.
With a combination of never-ending tax reform, the Tax Code's significant and complex changes, and the market volatility we've experienced over the past few years, clients need guidance more than ever. Practitioners who provide financial planning and investment advisory services are in a position to advise and assist their clients with these issues.
Practitioners just starting out in this arena may not possess the myriad skill sets and substantive knowledge required to embark on new business ventures.
CPAs who don't have all of the necessary talent in-house may find it easier to associate themselves with strategic "partners" who can provide the proper skill sets, training, technology, support and turnkey solutions in their specialized disciplines and niches, to help identify and meet their clients' financial goals.
Adapted from "The Team Approach to Tax, Financial & Estate Planning," edited by Lance Wallach, with chapters by Katharine Gratwick Baker, Fredda Herz Brown, Dr. Stanly J. Feldman, Ira Kaplan, Joseph W. Maczuga, Roger E. Nauheimer, Roger C. Ochs, Matthew J. O'Connor, Richard Preston, Steve Riley, Carl Lloyd Sheeler, Peter Spero, Paul J. Williams, and Roger M. Winsby. Product 017235.
Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
PROTECTING RETIREMENT BENEFITS THROUGH EDUCATING CUSTOMERS
Employee Plans News
EP Launches Web Section on Abusive Tax Shelter SchemesInternal Revenue Service
Tax Exempt and Government
Entities Division
A Publication of Employee Plans
As part of its effort to combat abusive tax shelter schemes and transactions, Employee Plans has launched a
new Web section containing important information about abusive schemes involving employee retirement plans.
The section warns promoters and plan professionals about the consequences of participating in such schemes.
It also provides a hotline for reporting suspected abusive transactions to the IRS.
The “EP Abusive Tax Transactions” section is on the Retirement Plans web page. The section identifies socalled “listed transactions” involving employee retirement plans and provides recently issued guidance – such
as Treasury regulations and IRS revenue rulings – intended to shut down transactions the IRS deems abusive.
To Read More:
http://www.irs.gov/pub/irs-tege/se0204.pdf
Will Your Municipal Bond or Your Life Insurance Company Still Have Value Next Year?
Published in The Finance Toolbox
By Lance Wallach
Investor protection with municipal bonds is so spotty that there is potential for much mischief.
Disclosure, that bedrock of fair securities markets, is the heart of the problem facing municipal investors. Municipal issuers often don’t file the most basic reports outlining their operating results or material changes in their financial conditions.
Even though hospitals, cities and states that borrow money are required by their bond covenants to make such filings, nondisclosure among the nearly 60,000 issuers is common.
With the S.E.C. largely on the sidelines, disclosure enforcement in the municipal market is left to participants. Do you think they really want to police themselves very closely? That leaves individuals who trade the securities, the investors, and the dealers, to monitor the disclosure information. There is almost no penalty for not complying with those requirements. This is another disaster waiting to happen. If you own municipal bonds, you had better be careful. You may want to investigate www.financeexperts.org and select someone that knows what they are doing to assist you.
Do you have a life insurance or annuity policy? If so, you may be in trouble. The plummeting financial markets are dragging down the life insurance industry, which is an important component of the U.S. economy. Continuously escalating losses weaken the companies’ capital and eat away at investor confidence.
More than a dozen life insurers have been awaiting action on applications for aid from the government’s $700 billion Troubled Asset Relief Program, and the industry is expecting an answer to its request for a bank-style bailout in the upcoming weeks. So far, the government hasn’t stated whether or not insurers qualify for the program.
Life insurers have undoubtedly been taking a beating in recent weeks. The Dow Jones Wilshire U.S. Life Insurance Index has fallen 82% since its May 2007 all time high. The Dow Jones Industrial Average has lost 21% this year to date.
Several of the hardest-hit companies are century-old names that insure the lives of millions of Americans. Shares of Hartford Financial Services Group Inc. are down 93% as of the close on Wednesday, March 11, 2009 from their 2008 high. MetLife Inc. and Prudential Financial Inc. are both suffering as the value of their vast investment portfolios declines.
As the economy weakens, analysts say many insurers face losses can eat away at the capital cushions regulators require them to maintain. In addition, experts say the industry is going through its most chaotic period in recent history and it’s a pretty scary situation right now.
The consequences of a weakened life-insurance industry for the overall economy are significant because life insurers are among the biggest holders of the nation’s corporate debt. For example, if life insurers stop buying bonds, the capital markets may not fully recover. Their buying activity has already declined.
Wall Street analysts say another problem for some life insurers is obligations for variable annuities, a retirement-income product that often guarantees minimum withdrawals or investment returns. As stock markets plunge to new lows, life insurers need to set aside additional funds to show regulators they can meet their obligations, further crimping sparse capital.
Life insurers’ woes have come largely from investment grade corporate bonds, commercial real estate and mortgages, regulatory filings show. Many insurers ended 2008 with high levels of losses that, due to accounting rules, they haven’t had to record on their bottom lines.
Hartford Financial had $14.6 billion in unrealized losses at year’s end. In addition, Hartford Insurance, through its agents, sold life insurance policies that were part of a welfare benefit plan popularly known as Niche Marketing, which has long been under IRS attack and is almost certainly regarded by the Service as an abusive tax shelter and/or listed transaction. Prudential, the second-largest insurer by assets, had nearly $11.3 billion in unrealized losses, up $5.4 billion in the fourth quarter from the previous quarter.
Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Class Action Challenges Propriety of 412(e)(3) Annuities
November 14, 2012 By Lance Wallach, CLU, CHFC
On August 1, 2012, a putative class action lawsuit was filed in the District of Connecticut challenging the propriety of certain insurance contracts used to fund defined benefit plans described in section 412(e)(3) of the Internal Revenue Code. U.S. Telemanagement, Inc. v. Fidelity Security Life Insurance Co. et al., No. 3:12-cv-1110 JBA (D. Conn.).
Because we perceive that the complaint is attacking the appropriateness of the product, as well as the specifics of the product that the named defendant sold, it is a lawsuit that potentially could have industry-wide implications. In addition, as plaintiffs in some of the ERISA revenue-sharing lawsuits have attempted to do, the complaint alleges that the insurance company that sold the annuities acted as an ERISA fiduciary of the plans. This lawsuit thus extends the attack on insurance companies, as seen in the revenue-sharing class actions, that attempts to convert service providers into fiduciaries.
412(e)(3) Plans and Annuities
A 412(e)(3) plan is a tax-qualified, defined benefit pension plan that is funded with either annuities or a combination of annuities and life insurance. These sorts of plans are most often funded through annuities, and those annuities have come to be known as 412(e)(3) annuities, because of the section of the Internal Revenue Code that authorizes this sort of plan. Such 412(e)(3) plans are normally marketed to small businesses as vehicles that can provide large income tax deductions in connection with the establishment or continued funding of a pension plan. The annuities used to fund such a plan often are priced upon low assumed rates of return and other actuarial factors, which means that the employer is required to contribute a larger amount of money up front to fund the plan, and that in turn provides employers with larger tax deductions for their business.
The Lawsuit
The plaintiffs are two small Connecticut businesses that purchased 412(e)(3) annuities from defendant Fidelity Security Life (“FSL”), a Kansas City-based insurance company. Plaintiffs also named as a defendant CJA Associates, Inc., a corporation that is a registered agent of FSL, and is alleged to have promoted the sale of the annuities, and First Actuarial Corporation (“FAC”), a wholly owned subsidiary of CJA that is alleged to have been the sponsor of the plans. In addition, the complaint names an individual who is a registered agent of FSL and is alleged to have served as a tax and investment advisor to the two plaintiff businesses (the complaint also alleges that he was recently indicted by a grand jury for income tax fraud, but does not allege if it was related to his conduct in this case). All of the non-FSL defendants are alleged to have had some role in the sales process.
Both of the plaintiffs purchased 412(e)(3) annuities from FSL, allegedly as part of the promotional efforts of CJA. Plaintiffs allege that one of the two plaintiffs had their income tax deductions associated with the plans disallowed. There are no allegations about the tax treatment of the income tax deductions of the second plaintiff, but we assume from that omission that its tax deductions have not been disallowed or challenged.
Plaintiffs contend that the FSL annuities were inappropriate and unsuitable for defined benefit retirement plans for two main reasons. First, plaintiffs contend that the loads used to pay commissions associated with the annuities -- which they claim amounted to 95% of the first year’s contributions and various percentages later on -- were excessive when compared to other annuity products “readily available in the marketplace that achieved the same goals.” The complaint alleges that two other prominent insurance companies were offering comparable yielding annuities with no upfront loads or fees and had their total commissions built into the structure of the product “within the industry standard of 5-6%.” Second, plaintiffs contend that the principal advantage of the product -- its ability to generate large income tax deductions -- was illusory because the employer’s contributions are excessive in relation to the actual costs of the claimed plan benefits, which means that the tax deductions employers have taken are vulnerable to being disallowed. Plaintiffs point to the fact that one of the plaintiffs’ tax deductions were disallowed as evidence of this point.
The complaint asserts four claims: (1) breach of fiduciary duty under ERISA, (2) breach of ERISA’s co-fiduciary provisions, (3) non-fiduciary liability for knowing participation in a breach, and (4) prohibited transactions under section 406(a)(1)(C), the party-in-interest provisions. These are the same types of claims that we have seen asserted in ERISA revenue-sharing class action complaints against 401(k) plan service providers.
Like the claims in those cases, plaintiffs in this new class action claim that all of the defendants acted as fiduciaries of the two plans in various ways, and that defendants act in a similar fiduciary capacity for all plans in the putative class. Plaintiffs contend that all of the defendants acted as fiduciaries with respect to the conduct at issue because they exercised discretion and control over the plans’ assets, and offered investment advice for a fee with respect to monies of the plans (i.e., under section 3(21)(A)(i) and (ii) of ERISA). With respect to defendant CJA, which also allegedly acted as plan sponsor, plaintiffs also claim that it acted as a fiduciary because it had discretionary authority and responsibility in the administration of the plans (i.e., under section 3(21)(A)(iii) of ERISA).
Plaintiffs are pursuing their claims as a class action, and seek to represent the following class: all investors of employee benefit plan trust money under a CJA or FAC prototype or master employee benefit plan whose plan trust money was invested in FSL’s section 412(e)(3) annuities. The class is defined to exclude any investors who signed agreements to arbitrate any disputes arising from their investments.
Plaintiffs seek unspecified damages, but they ask the Court to presume that, if the investments had not been made in the FSL annuities, the assets would have been invested in the most profitable alternative investments available to them. As is common in ERISA cases, plaintiffs do not allege what more profitable alternative investments were available, aside from other annuities with comparable returns.
Potential Impact of this Case
We see at least three potential impacts from this new case. First, there is a potential that this class action will spawn a new wave of class actions directed at insurance companies that have sold 412(e)(3) annuities. Although plaintiffs nominally contend that the FSL annuities were unsuitable “as structured,” the complaint reads like a general attack on the suitability of such annuities under any circumstance, and a general attack on the insurance companies who acted as service providers with respect to retirement plans that were funded with 412(e)(3) annuities. Thus, as with the revenue-sharing class actions, where plaintiff’s counsel sued most major insurance company service providers, the Fidelity Life class action could be the first among many filed against the insurance industry.
Second, this lawsuit continues the unrelenting efforts by the ERISA class action plaintiffs’ bar to try to transform insurance companies – mere sellers of retirement products and services – into ERISA fiduciaries. We first observed these efforts in earnest in the revenue-sharing class actions we have defended, and this case appears to continue the trend in which plaintiffs attempt to recast ministerial tasks or sales efforts as fiduciary conduct. The rulings in this case could contribute to the developing body of law regarding what activities can cause entities to qualify as ERISA fiduciaries.
Third, this lawsuit could trigger other non-412(e)(3) lawsuits claiming that other life insurance or annuity-based retirement products and services are “too expensive” or “unsuitable” for retirement plans. We have already observed these same sort of efforts in the ERISA stock drop cases we have defended, in which plaintiffs contend that company stock was unsuitable, and more recently, in some of the plan sponsor revenue-sharing cases, in which plaintiffs contend that certain mutual fund offerings used as investment options are too expensive. This lawsuit could cause the ERISA class action plaintiffs’ bar to look for other types of products for which it could pursue similar claims.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
ABOUT THE AUTHOR: Lance Wallach
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He is an American Institute of CPA’s course developer and instructor and has authored numerous best selling books about abusive tax shelters, IRS crackdowns and attacks and other tax matters. He speaks at more than 20 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.vebaplan.com, www.taxlibrary.us, lawyer4audits.com or call 516-938-5007
Copyright Lance Wallach, CLU, CHFC
More information about Lance Wallach, CLU, CHFC
412(e)(3) Plans and Annuities
A 412(e)(3) plan is a tax-qualified, defined benefit pension plan that is funded with either annuities or a combination of annuities and life insurance. These sorts of plans are most often funded through annuities, and those annuities have come to be known as 412(e)(3) annuities, because of the section of the Internal Revenue Code that authorizes this sort of plan. Such 412(e)(3) plans are normally marketed to small businesses as vehicles that can provide large income tax deductions in connection with the establishment or continued funding of a pension plan. The annuities used to fund such a plan often are priced upon low assumed rates of return and other actuarial factors, which means that the employer is required to contribute a larger amount of money up front to fund the plan, and that in turn provides employers with larger tax deductions for their business.
The Lawsuit
The plaintiffs are two small Connecticut businesses that purchased 412(e)(3) annuities from defendant Fidelity Security Life (“FSL”), a Kansas City-based insurance company. Plaintiffs also named as a defendant CJA Associates, Inc., a corporation that is a registered agent of FSL, and is alleged to have promoted the sale of the annuities, and First Actuarial Corporation (“FAC”), a wholly owned subsidiary of CJA that is alleged to have been the sponsor of the plans. In addition, the complaint names an individual who is a registered agent of FSL and is alleged to have served as a tax and investment advisor to the two plaintiff businesses (the complaint also alleges that he was recently indicted by a grand jury for income tax fraud, but does not allege if it was related to his conduct in this case). All of the non-FSL defendants are alleged to have had some role in the sales process.
Both of the plaintiffs purchased 412(e)(3) annuities from FSL, allegedly as part of the promotional efforts of CJA. Plaintiffs allege that one of the two plaintiffs had their income tax deductions associated with the plans disallowed. There are no allegations about the tax treatment of the income tax deductions of the second plaintiff, but we assume from that omission that its tax deductions have not been disallowed or challenged.
Plaintiffs contend that the FSL annuities were inappropriate and unsuitable for defined benefit retirement plans for two main reasons. First, plaintiffs contend that the loads used to pay commissions associated with the annuities -- which they claim amounted to 95% of the first year’s contributions and various percentages later on -- were excessive when compared to other annuity products “readily available in the marketplace that achieved the same goals.” The complaint alleges that two other prominent insurance companies were offering comparable yielding annuities with no upfront loads or fees and had their total commissions built into the structure of the product “within the industry standard of 5-6%.” Second, plaintiffs contend that the principal advantage of the product -- its ability to generate large income tax deductions -- was illusory because the employer’s contributions are excessive in relation to the actual costs of the claimed plan benefits, which means that the tax deductions employers have taken are vulnerable to being disallowed. Plaintiffs point to the fact that one of the plaintiffs’ tax deductions were disallowed as evidence of this point.
The complaint asserts four claims: (1) breach of fiduciary duty under ERISA, (2) breach of ERISA’s co-fiduciary provisions, (3) non-fiduciary liability for knowing participation in a breach, and (4) prohibited transactions under section 406(a)(1)(C), the party-in-interest provisions. These are the same types of claims that we have seen asserted in ERISA revenue-sharing class action complaints against 401(k) plan service providers.
Like the claims in those cases, plaintiffs in this new class action claim that all of the defendants acted as fiduciaries of the two plans in various ways, and that defendants act in a similar fiduciary capacity for all plans in the putative class. Plaintiffs contend that all of the defendants acted as fiduciaries with respect to the conduct at issue because they exercised discretion and control over the plans’ assets, and offered investment advice for a fee with respect to monies of the plans (i.e., under section 3(21)(A)(i) and (ii) of ERISA). With respect to defendant CJA, which also allegedly acted as plan sponsor, plaintiffs also claim that it acted as a fiduciary because it had discretionary authority and responsibility in the administration of the plans (i.e., under section 3(21)(A)(iii) of ERISA).
Plaintiffs are pursuing their claims as a class action, and seek to represent the following class: all investors of employee benefit plan trust money under a CJA or FAC prototype or master employee benefit plan whose plan trust money was invested in FSL’s section 412(e)(3) annuities. The class is defined to exclude any investors who signed agreements to arbitrate any disputes arising from their investments.
Plaintiffs seek unspecified damages, but they ask the Court to presume that, if the investments had not been made in the FSL annuities, the assets would have been invested in the most profitable alternative investments available to them. As is common in ERISA cases, plaintiffs do not allege what more profitable alternative investments were available, aside from other annuities with comparable returns.
Potential Impact of this Case
We see at least three potential impacts from this new case. First, there is a potential that this class action will spawn a new wave of class actions directed at insurance companies that have sold 412(e)(3) annuities. Although plaintiffs nominally contend that the FSL annuities were unsuitable “as structured,” the complaint reads like a general attack on the suitability of such annuities under any circumstance, and a general attack on the insurance companies who acted as service providers with respect to retirement plans that were funded with 412(e)(3) annuities. Thus, as with the revenue-sharing class actions, where plaintiff’s counsel sued most major insurance company service providers, the Fidelity Life class action could be the first among many filed against the insurance industry.
Second, this lawsuit continues the unrelenting efforts by the ERISA class action plaintiffs’ bar to try to transform insurance companies – mere sellers of retirement products and services – into ERISA fiduciaries. We first observed these efforts in earnest in the revenue-sharing class actions we have defended, and this case appears to continue the trend in which plaintiffs attempt to recast ministerial tasks or sales efforts as fiduciary conduct. The rulings in this case could contribute to the developing body of law regarding what activities can cause entities to qualify as ERISA fiduciaries.
Third, this lawsuit could trigger other non-412(e)(3) lawsuits claiming that other life insurance or annuity-based retirement products and services are “too expensive” or “unsuitable” for retirement plans. We have already observed these same sort of efforts in the ERISA stock drop cases we have defended, in which plaintiffs contend that company stock was unsuitable, and more recently, in some of the plan sponsor revenue-sharing cases, in which plaintiffs contend that certain mutual fund offerings used as investment options are too expensive. This lawsuit could cause the ERISA class action plaintiffs’ bar to look for other types of products for which it could pursue similar claims.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
ABOUT THE AUTHOR: Lance Wallach
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He is an American Institute of CPA’s course developer and instructor and has authored numerous best selling books about abusive tax shelters, IRS crackdowns and attacks and other tax matters. He speaks at more than 20 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.vebaplan.com, www.taxlibrary.us, lawyer4audits.com or call 516-938-5007
Copyright Lance Wallach, CLU, CHFC
More information about Lance Wallach, CLU, CHFC
PROTECTING RETIREMENT BENEFITS THROUGH EDUCATING CUSTOMERS
Employee Plans News
EP Launches Web Section on Abusive Tax Shelter Schemes
Internal Revenue Service
Tax Exempt and Government
Entities Division
A Publication of Employee Plans
As part of its effort to combat abusive tax shelter schemes and transactions, Employee Plans has launched a
new Web section containing important information about abusive schemes involving employee retirement plans.
The section warns promoters and plan professionals about the consequences of participating in such schemes.
It also provides a hotline for reporting suspected abusive transactions to the IRS.
The “EP Abusive Tax Transactions” section is on the Retirement Plans web page. The section identifies socalled “listed transactions” involving employee retirement plans and provides recently issued guidance – such
as Treasury regulations and IRS revenue rulings – intended to shut down transactions the IRS deems abusive.
To Read More:
http://www.irs.gov/pub/irs-tege/se0204.pdf
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