Non-Discrimination
Section 79 Plans are “employee-benefit” plans. As such, employers are not supposed to discriminate in favor of key employees or business owners.
As you know from Part I, Section 79 Plans are implemented so business owners can take a business deduction for the purchase of an individually owned cash value life insurance policy that the owner can borrow from tax free in retirement.
It sounds great until you break down the math and understand that a client would be better off paying taxes on his/her money, taking it home, and funding a “good” cash value life policy (Retirement Life™ ) vs. the low cash accumulation Section 79 Plan policy.
Notwithstanding the math behind Section 79 Plans, let’s talk about the benefits for employees. The employee owner is going to buy a “permanent” policy that will carry cash and can be borrowed from tax free in retirement.
That SAME policy must be offered to ALL employees. If that actually happened in a full-disclosure manner, virtually all the employees would opt for the same permanent policy as the business owner; and if that happened, the finances of the plan would really go out the window because of the tremendous costs for the employees.
How do you “work around” this issue?
The work around of this issue is a bit clever and deceptive. The employees will be scared into voluntarily opting for $50,000 of term insurance instead of the full-benefit policy (term or permanent).
Why would an employee opt for $50,000 in term instead of a policy with several hundred thousands of dollars or even millions of dollars in death benefits? Because employees who are provided death benefits by an employer in excess of $50,000 are taxed on the additional benefit on an annual basis (and it increases every year).
The scare pitch
You sit the employees down in a room and tell them that the business is going to be implementing a Section 79 Plan as a new employee-benefit plan.
Initially, all the employees are shocked and pleased.
Then the person doing the enrollment meeting tells the employees that they can receive for free $50,000 of term insurance or more death benefit coverage. However, the employees are told they will get an income tax bill for the additional coverage. The employee is typically led to believe that the tax bill will be quite high and that this will be money out of their pocket when they pay the tax on income they did not receive.
Then they are all given the opt-out form for the higher amount where they all opt for $50,000 of term life insurance.
The numbers
When you see the numbers, you’ll know why an employee would have to be truly stupid not to opt for the full benefit and why it is so important to scare employees to opt out.
What you’ll notice is that the cost of having the employees opt for permanent policies totals $27,594 a year and that the cost for the employees’ opting for $50,000 in term totals $475 a year.
What you’ll notice is that the taxable income for the employee with the highest amount of recapturable income is $6,112 a year for a $9,404 corporate premium. $6,112 is not the tax; it’s the additional income.
If the employee is in the 20% tax bracket, that’s an additional income tax bill of only $1,222 a year. Would Employee #1 below pay $1,222 a year to have the employer fund $9,404 as a premium into a permanent cash value life insurance policy that can be borrowed from tax free in retirement? This, of course, is a question that only has one answer. Employee #1 would also have to recapture $264 of additional income for insurance provided above $50,000 of term coverage.
Eligible Employees
Employee M/F DOB Salary Death Benefit
Dr. Green M 1/1/59 $322,659 $1,774,623
EE#1 F 1/1/74 59,000 324,500
EE#2 M 1/1/69 25,000 137,500
EE#3 F 1/1/64 34,000 187,000
EE#4 M 1/1/59 17,680 97,340
Plan Benefits
Full Permanent Insurance
Employee Death Benefit Corp Premium EE Perm Cost Table I
Dr. Green $1,774,623 $100,000 $63,610 $3,194
EE#1 324,500 9,404 6,112 264
EE#2 137,500 5,526 3,591 95
EE#3 187,000 7,583 4,928 165
EE#4 97,240 5,441 3,536 86
Full Term Insurance
Employee Death Benefit Corp Premium Table I
Dr. Green $1,774,623 $4,308 $3,194
EE#1 324,500 258 264
EE#2 137,500 165 95
EE#3 187,000 278 165
EE#4 97,240 311 86
$50,000 Term
Employee Death Benefit Corp Premium
Dr. Green $50,000 $177
EE#1 50,000 81
EE#2 50,000 102
EE#3 50,000 115
EE#4 50,000 177
Summary
Should insurance agents be selling Section 79 Plans?
Sure, if they like the idea of lying or withholding information from clients to make the sale.
Should business owners be buying Section 79 Plans?
Sure, if they the idea of buying a tax-deductible plan that is not even as good as funding a “good” cash value life insurance with their after-tax take home pay.
Sure, if the business owner doesn’t mind putting on an intentionally deceptive enrollment meeting for employees where they are lied to so the plan can be implemented in a financially economical manner.
I think that the “Section 79 Plan” is one of the most abused concepts in the industry today, and I hope my full disclosure information on these plans has been helpful to you so you can make the decision about these plans.
