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
The invention claimed is:
1. A method for making substitute continuing payments into a trust
of a retirement plan, into which contribution payments are normally
made on behalf of an employee participating in the plan, during
a period of non-payment due to a long-term disability of the employee,
comprising: a. including a disability insurance policy as a feature
of the plan; b. holding the insurance policy as an asset of the
plan's trust; c. providing a computer processing system for performing
the steps of: (i) receiving information relating to said employee's
pre-disability contribution amount; and (ii) calculating, based
on said information, 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; d. paying the premium amount calculated by the computer
system with assets of the trust; and e. receiving the disability
benefit amount calculated by the computer system into the plan's
trust.
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 tax
qualified 401(k) plan, thereby subjecting said insurance policy
to the terms of said 401(k) plan, including the IRS and DOL rules
and regulations to which the 401(k) plan itself is subject.
4. The method of claim 1, wherein said disability benefits payable
under the insurance policy are received into the trust as investment
return of the trust.
5. The method of claim 1, wherein, in accordance with provisions
of the IRC and its attendant rules and regulations, the plan is
subject to non-discrimination requirements with regard to eligibility
for the insurance, and performing the step of matching eligibility
for said insurance to eligibility for the plan, performing the step
of matching eligibility for the insurance to participation in the
plan, or both.
6. The method of claim 1, wherein, in accordance with the provisions
of the IRC and its attendant rules and regulations, the plan is
subject to non-discrimination requirements with regard to premiums
for the insurance and benefits under the insurance, and performing
the step of linking said premiums and benefits to pre-disability
contributions to the plan, said pre-disability contributions having
been demonstrated to meet the plan's non-discrimination requirements
by definition or by testing.
7. The method of claim 6, 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.
8. The method of claim 6, 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.
9. The method of claim 1, wherein the trust includes an individual
account allocated to each participating employee and the insurance
premium for each said employee is paid from said employee's account.
10. The method of claim 1, wherein the trust includes an individual
account allocated to each participating employee, the computer processing
system further calculates a total annual premium for all participating
employees, and step (d) includes paying said total annual premium
on an overall-plan basis from the trust as a plan expense.
11. The method of claim 10, wherein said total annual premium is
paid from a specific account, source, or fund held in the trust.
12. The method of claim 10, wherein said total annual premium is
paid from the earnings of the trust prior to the earnings being
allocated to said individual participant accounts.
13. A method for making substitute continuing payments into a trust
of a retirement plan, into which contribution payments are normally
made on behalf of an employee participating in the plan, during
a period of non-payment due to a long-term disability of the employee,
comprising: a. including a disability insurance policy as a feature
of the plan; b. holding the insurance policy as an asset of the
plan's trust; c. providing a computer processing system for performing
the steps of: (i) receiving information relating to said employee's
pre-disability contribution amount; and (ii) calculating, based
on said information, 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; d. paying the premium amount calculated by the computer
system with assets of the trust; and e. receiving the disability
benefit amount calculated by the computer system into the plan's
trust, wherein, in accordance with provisions of the IRC and its
attendant rules and regulations, the plan is subject to non-discrimination
requirements with regard to eligibility for the insurance, and performing
the step of matching eligibility for said insurance to eligibility
for the plan, performing the step of matching eligibility for said
insurance to participation in the plan, or both for the plan year
prior to the policy year for which the insurance is effective.
14. A method for making substitute continuing payments into a trust
of a retirement plan, into which contribution payments are normally
made on behalf of an employee participating in the plan, during
a period of non-payment due to a long-term disability of the employee,
comprising: a. including a disability insurance policy as a feature
of the plan; b. holding the insurance policy as an asset of the
plan's trust; c. providing a computer processing system for performing
the steps of: (i) receiving information relating to said employee's
pre-disability contribution amount; and (ii) calculating, based
on said information, 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; d. paying the premium amount calculated by the computer
system with assets of the trust; and e. receiving the disability
benefit amount calculated by the computer system into the plan's
trust, wherein, in accordance with the provisions of the IRC and
its attendant rules and regulations, the plan is subject to non-discrimination
requirements with regard to premiums for the insurance and benefits
under the insurance, and performing the step of linking said premiums
and benefits to the contributions to the plan for the plan year
prior to the policy year for which the insurance is effective, said
contributions having been demonstrated to meet the plan's non-discrimination
requirements by definition or by testing.
15. A method for making substitute continuing payments into a trust
of a defined contribution 457 plan, into which contribution payments
are normally made on behalf of an employee participating in the
plan, during a period of non-payment due to a long-term disability
of the employee, comprising: a. including a disability insurance
policy as a feature of the 457 plan; b. holding the insurance policy
as an asset of the plan's trust; c. providing a computer processing
system for performing the steps of: (i) receiving information relating
to said employee's pre-disability contribution amount; and (ii)
calculating, based on said information, 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; d. paying the premium
amount calculated by the computer system with assets of the trust;
and e. receiving the disability benefit amount calculated by the
computer system into the plan's trust, wherein said insurance policy
is subject to the terms of said 457 plan, including the IRS and
DOL rules and regulations to which the 457 plan itself is subject.
16. A method for making substitute continuing payments into a trust
of a defined contribution 403(b) plan, into which contribution payments
are normally made on behalf of an employee participating in the
plan, during a period of non-payment due to a long-term disability
of the employee, comprising: a. including a disability insurance
policy as a feature of the 403(b) plan; b. holding the insurance
policy as an asset of the plan's trust; c. providing a computer
processing system for performing the steps of: (i) receiving information
relating to said employee's pre-disability contribution amount;
and (ii) calculating, based on said information, 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; d. paying the premium
amount calculated by the computer system with assets of the trust;
and e. receiving the disability benefit amount calculated by the
computer system into the plan's trust, wherein said insurance policy
is subject to the terms of said 403(b) plan, including the IRS and
DOL rules and regulations to which the 403(b) plan itself is subject.
17. A method for making 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,
the method comprising: a. including a disability insurance policy
as a feature of the plan; b. holding the insurance policy as an
asset of the plan's trust; c. providing a computer processing system
for performing the steps of: (i) receiving information relating
to said participant's pre-disability contribution amount; and (ii)
calculating, based on said information, 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; d. paying the premium
amount calculated by the computer system with assets of the trust;
and e. receiving the disability benefit amount calculated by the
computer system into the plan's trust, wherein the plan is subject
to non-discrimination requirements with regard to eligibility for
the insurance, and performing the step of matching eligibility for
the insurance to eligibility for the plan, performing the step of
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.
18. The method of claim 17, 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.
19. The method of claim 17, wherein the retirement plan is a tax
qualified 401(k) plan, thereby subjecting said insurance policy
to the terms of said 401(k) plan, including the IRS and DOL rules
and regulations to which the 401(k) plan itself is subject.
20. The method of claim 17, wherein said disability benefits are
received into the trust as investment return of the trust.
21. The method of claim 17, 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.
22. The method of claim 17, wherein the computer processing system
further calculates a total annual premium for all plan participants,
and step (d) includes paying said total annual premium on an overall-plan
basis from the trust as a plan expense.
23. The method of claim 22, 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.
24. The method of claim 17, wherein the retirement plan is either
a 403(b) plan or a 457 plan.
25. A method for making 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,
the method comprising: a. including a disability insurance policy
as a feature of the plan; b. holding the insurance policy as an
asset of the plan's trust; c. providing a computer processing system
for performing the steps of: (i) receiving information relating
to said participant's pre-disability contribution amount; and (ii)
calculating, based on said information, 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; d. paying the premium
amount calculated by the computer system with assets of the trust;
and e. receiving the disability benefit amount calculated by the
computer system into the plan's trust, wherein the plan is subject
to non-discrimination requirements with regard to premiums for the
insurance and benefits under the insurance, and performing the step
of linking said premiums and benefits 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.
26. The method of claim 25, 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.
27. The method of claim 25, wherein the retirement plan is a tax
qualified 401(k) plan, thereby subjecting said insurance policy
to the terms of said 401(k) plan, including the IRS and DOL rules
and regulations to which the 401(k) plan itself is subject.
28. The method of claim 25, wherein said disability benefits are
received into the trust as investment return of the trust.
29. The method of claim 25, 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.
30. The method of claim 25, wherein the computer processing system
further calculates a total annual premium for all plan participants,
and step (d) includes paying said total annual premium on an overall-plan
basis from the trust as a plan expense.
31. The method of claim 30, 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.
32. The method of claim 25, wherein the retirement plan is either
a 403(b) plan or a 457 plan.
33. The method of claim 25, 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.
34. The method of claim 25, 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.
Insurance description
BACKGROUND OF THE INVENTION
1. Field of the Invention
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.
2. Description of the Related Art
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 executive wealth accumulation
programs).
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.
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.
(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.)
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
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
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.
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.
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:
Qualifying the Exposure
The diminution in inflation adjusted retirement income for every
$1000 of annual employer pre-tax or employer matching contribution:
TABLE-US-00001 If disability occurs And continues to age: 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: 1. 4% real rate
of return (that is, inflation adjusted) 2. Plan withdrawals over
15 years starting at age 65 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.
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
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
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. 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. 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.
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
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. 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. 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. 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
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.
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. 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. Problem Three--An
HCEs 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
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.
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
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:
1. He/she does not have the invention and does not become disabled;
2. He/she has the invention and does not become disabled;
3. He/she does not have the invention and becomes disabled;
4. He/she has the invention and becomes disabled.
For sake of simplicity, it will be assumed that disability for
participants in situation 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
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
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
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
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
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
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).
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
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
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
The following tests must be applied to determine that the insurance
offered within the plan meets the non-discrimination requirements
of a retirement plan.
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.
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.
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.
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.
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
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.
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.
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.
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.
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.
Yet a further object of the present invention is to provide insurance
against loss of retirement contributions during disability through
a vehicle which minimizes risk that the benefits may not be saved
for retirement, as intended.
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).
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).
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.
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
FIG. 1 is a procedural flow chart illustrating how the record keeping
software and disability application work together to share information.
FIG. 2 is a flow chart showing the timing of the data exchange
between the record keeping system and the disability software.
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.
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
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
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
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.
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: 1. The amount of coverage for the current policy year is equal
to insured plan contributions for the prior plan year. 2. The eligible
group for the current policy year is determined by plan participation
in the prior plan year. 3. Premiums for the current policy year
are paid from the prior plan year's contributions and/or earnings.
4. The insurance is tested under the tax rules for non-discrimination
in the prior plan year.
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
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 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
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.
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.
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
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:
1. The policyholder is the trustee of the insured plan. 2. The policy
year of the insurance contract is matched to the plan year of the
plan (i.e. January 1 December 31, etc). 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. 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. 5. The premium for the current
year is paid by the trustee from the prior year's contributions
or investment earnings. 6. The elimination period between the occurrence
of the disability and the commencement of benefits is at least 365
days. 7. The policy provides for benefits to be paid to the plan
in the event of an insured's long-term disability. 8. Disability
benefits will cease if they are withdrawn from the plan during the
disability period. Methodology of the Invention The following functions,
processes, and calculations are necessary to apply the basic principles
of the invention to plan administration processes. I. Underwriting/Renewal
Process 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: Participant/record identifier (i.e. SSN) Gender Occupation
Code Date of Birth Date of Hire YTD compensation (W-2 pay from plan
entry date, [ok if capped at $160,000]) YTD contributions (by source
for insured sources only) 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. Process 2--Prepare file
with renewal data and send to the insurer. II. Annual Eligibility
Determination 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.
Requirements to be in Eligibility Group: 1. Contribution made for
an Insured Source in the Plan Year prior to the Policy Year; and,
2. No Date of Termination prior to the last day of the prior Plan
Year. 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. 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. 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
directed to the Insurance Premium Fund as a new money source for
the prior year. III. Monthly Premium Transactions 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. 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. 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 Process 1 --If at any time during the policy year the
amount 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. 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
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. 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 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. Process
2 --Produce reports for the insurer of total covered lives, total
insurance in force, and total premiums paid for the policy year.
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. 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
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. 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 participant's
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. 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. 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). 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) 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). 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
The disability application will receive data from: 1. An automatic
import from the record keeping system. 2. Manual file load from
employer's HRIS records. 3. Manual input of insurance rates from
insurer, disability payment status, disability payment amount, etc.
Database Elements
The disability application will require new database elements within
the record keeping system at the System Level, the Plan Level, and
the Participant Level.
System Level Information Disability premium transaction code Disability
benefit payment transaction code Plan Level Information Additional
fund--Disability Premiums Additional source of money--Disability
Benefits Source flag for all sources--Contribution Eligible for
Disability Insurance Flag for Disability Source--Exclude Source
from Compliance testing Annual Effective Date Current Effective
Date Disability Premium Rate Coverage Percentage--percent of Eligible
Contribution to be insured Voluntary--Y or N whether Disability
Insurance is elective Premium Source Flag--which Source Premiums
are paid from
Participant Level Information (* Indicates data elements already
held within record keeping system. All other data elements are new.)
*Social Security Number *Name *Address *City State Zip *Date of
Birth *Date of Hire/Rehire *Date of Termination Sex Occupation Code
Election to Participate Flag Coverage Effective Date Disability
Date Disability Payment Start Date Disability Benefit Status Annual
Coverage Amounts (by Source) Annual Premium Amounts (by Source)
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
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
1. Export Annual Disability File
2. Import Premium File
3. Process Annual Premium Transfers
4. Process Monthly Premiums
5. Process Monthly Disability Payments
Disability Application Menu Elements
1. Import Annual Disability File
2. Calculate Annual Coverage/Premiums
3. Export Premium File
4. Year-End Archive
5. Reporting
Flowcharts and Diagrams
FIG. 1--Disability Compensation Plan Procedural Flowchart
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
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
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 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
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.
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: 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. 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. Third--beneficiary payments for
a participant receiving a disability benefit would be handled exactly
as "Process V--Beneficiary Payment Deposits." 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. Fifth--Steps 4, 6, and 7 would be the only required
processes under "Process VII--Annual Compliance Testing/Reporting."
Individual Disability Policies
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:
First--the underwriting and annual eligibility would be as described
in Processes I and II.
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. Third--Processes IV,
V, VI, and VII would be as described. Application to Other Defined
Contribution Plans Other Employee Deferrals
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.
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
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.
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.
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.
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. |