What is it?

1. What is it? • Rather than electing to receive a normal joint and survivor annuity from a pension plan, the retiring participant , with consent of spouse selects the higher single life annuity option • The couple purchases a life insurance policy on the participant to assure financial security in the event the participant dies first and pension benefits cease • The difference between the joint and survivor annuity and the single life annuity is available to pay premiums on the insurance • When is the use of such a device indicated • When more flexible survivor options than those provided by a qualified plan’s joint and survivor option are desired • When the participant’s spouse is in poor health

2. When is the use of such a device indicated (cont'd) • When the participant’s spouse has income and asset resources that can provide some of the spouse’s required income needs if the participant predeceases the spouse • When the participant already has life insurance in place for his or her life that can provide the bulk of the surviving spouse’s retirement income needs in the event the participant predeceases the spouse • Pension maximization strategy is more feasible if the participant is female • Pension benefits based on unisex mortality factors • Most life insurance policies priced according to sex-based factors • Relative costs of survivor benefits acquired through insurance will be generally less than the cost of those same benefits acquired from a qualified plan

3. Advantages • Planning flexibility • Insurance feature of Joint & Survivor (J&S) annuity has several unattractive elements: • Participant will receive the lower J&S benefit payments even if spouse predeceases participant and the survivorship feature is no longer needed • Lack of flexibility with the J&S annuity feature • Only option is in the selection of the survivor’s ratio. The default ratio is 50%, but election could include 66&2/3rd %, 75% or even 100%. • As the survivor ratio goes up, the benefit typically goes down • Pensioner has no rights to (1) accelerated benefit payments and (2) choose a substitute beneficiary if the spouse predeceases the participant or (3) wait to select what type of benefit payout pattern will be paid to the surviving spouse if the participant dies first

4. Advantages (cont'd) • Pension maximization attractive because life insurance policy offers more planning flexibility • Options if the spouse dies prior to the participant • Keep policy inforce and name a new beneficiary (child, grandchildren, charity) • Suspend premium payments and increase his/her spendable retirement income • If the policy has cash value • Elect the reduced paid-up or extended term insurance Nonforfeiture Options • Surrender the policy for its cash value

5. Advantages (cont'd) • Options for the surviving spouse • J&S annuity provides only one option – life annuity • If not in good health, surviving spouse can elect a higher benefit, limited and guaranteed term annuity • Wait and see approach • Set up a trust to receive the insurance proceeds • Trustee is given discretion as to how to distribute the funds to best insure the surviving spouse’s financial security • Payments could be accelerated to meet special needs such as large medical expenses • Insurance policy provides more flexibility to handle special or changing needs while both participant and spouse are alive • Borrow cash value or accelerate benefits

6. Disadvantages • Life insurance option has costs and risks • Pension maximization plan that is implemented some years before retirement will generally cost less than one that is implemented later • Risk that the premium is not paid and the insurance will not be in force when it is needed • What are the requirements? • Compliance with the requirements of the Retirement Equity Act of 1984 (REA) • Required spousal benefits • Qualified pre-retirement survivor annuity (QSPA) • Automatic election unless the participant and spouse have made a proper election otherwise

7. What are the requirements? (cont'd) • Annuity starting date • Key date for determining whether benefits are payable as a QPSA or a QJSA or another selected optional form of benefit payable under the plan • Living participant on the annuity starting date must have benefits as a QJSA, unless the participant and spouse have made a qualifying election otherwise • Surviving spouse of a participant who died before the annuity starting date must receive a QPSA unless election for another benefit was properly elected by both participant and spouse previously • Annuity starting date – Key date for purposes of determining whether benefits are payable as a QPSA or QJSA or another form of benefit payable under the plan

8. What are the requirements? (cont'd) • Annuity starting date • First day of the first period for which an amount is paid as an annuity or in any other form as a retirement benefit under the plan • Usually it is the normal retirement age • For participants who retire early • Earliest date that benefits may begin for early retirement or the first date when benefits are payable after retirement if later. • REA requirements apply generally to all qualified pension plans • Plans include defined benefit plans, money purchase, target benefit and cash balance plans

9. What are the requirements? (cont'd) • REA requirements apply generally to all qualified pension plans (cont'd) • Defined benefit plan • Survivor annuity requirement applies only to benefits in which the participant was vested immediately before death • Survivor annuity requirements also apply to nonforfeitable benefits payable under any defined contribution plan that is subject to the minimum funding standards of IRC section 412 • Exception for profit sharing and stock bonus plans and ESOP’s - These plans must conform unless all of the following requirements are met • Each participant’s vested benefit is payable on the death of the surviving spouse, or, if there is no spouse, to a designated beneficiary • The participant has not elected to receive benefits in the form of a life annuity • The qualified benefit plan is not the recipient of a direct plan-to-plan transfer of benefits from a defined benefit, money purchase, target benefit or cash balance pension plan

10. What are the requirements? (cont'd) • Exception for profit sharing and stock bonus plans and ESOP’s – (cont'd) • Benefits must be available to the surviving spouse within a reasonable time after the participant’s death • Access within 90 days is considered reasonable • If these requirements are met • Participant does not need spouse’s consent to take living benefits in some form other than joint and survivor annuity • Permitted options would include • Term certain annuities • Discretionary installments • Lump sum distributions

11. What are the requirements? (cont'd) • Exception for certain benefits – Benefits not required to be paid as QPSA or QJSA if : • At the time of death or distribution the employee was vested only in employee contributions and the participant died, or distributions commenced prior to October 22nd, 1986, or • If the present value of the participants nonforfeitable benefit is $5,000 or less • REA requirements do not apply to IRAs • Qualified pre-retirement survivor annuity (QPSAs) • A property right of the spouse, created by law • Survivor benefit is an immediate annuity for the life of the participant’s spouse

12. What are the requirements? (cont'd) • Qualified pre-retirement survivor annuity (QPSAs) (cont'd) • Defined benefit plan • Must permit surviving spouse to elect to receive payments under a QPSA no later than the month in which the participant would have reached the earliest retirement age • The participant may elect an alternative form of benefit, but only with the spousal consent • What form of benefit and who should be beneficiary in the event of the participant death prior to retirement is often overlooked. • For example, if spouse has adequate pension benefits in the spouse’s own right, the participant may want to name a child, parent, charity or other persons as beneficiaries of the retirement benefits • Participant may select a benefit other than the pre-retirement survivor annuity at any time after age 35 and change this election at anytime before retirement • Electing out of the pre-retirement survivor annuity generally increases the benefit payable at retirement

13. What are the requirements? (cont'd) • Qualified Joint and Survivor Annuity (QJSA) • Spouse’s survivor benefit may not be less than 50% and not more than 100% • If the plan offers two QJSA’s that are actuarially equivalent, the plan must specify which is the QJSA • The participant may elect the other equivalent QJSA without spousal consent • An election to waive the normal form of joint and survivor benefit must be made during a 90 day period ending on the annuity starting date • Spousal consent not effective unless • Consent is in writing • The election designates a beneficiary who may not be changed without spousal consent

14. What are the requirements? (cont'd) • Spousal consent not effective unless (cont'd) • The election designates a form of benefit, which may not be changed without spousal consent • The consent acknowledges the effect of such election on benefit rights and • The consent is witnessed by a plan representative or a notary public • How it is done – an example

15. How it is done – an example (cont'd) • Example • Spouse age 60. • J&S annuity is $24,000. • Pension benefit indexed for inflation at 4%. • Assume a 5.5% after tax return • Combined tax rate of 31% • Maximum COLA of 4% • Life expectancy of 24.2 years

16. What are the tax implications? • Income taxation is deferred until distributions are received • Distributions from a qualified plan will generally be taxed in their entirety • Unless the participant acquired some non-taxable basis in the plan • Life insurance proceeds are generally paid income-tax free • Planners will have to consider the difference in taxation of the benefits to determine the amount of insurance required • Planners must recognize the amount available to pay premiums (if the participant elects a SL annuity rather than a J&S annuity) must be adjusted for taxes

17. What are the tax implications? (cont'd) • The value of a survivor benefit from a qualified plan will be included in the taxable estate of the participant • If spouse is named as beneficiary – it qualifies for the marital exclusion • If the participant retains any incidents of ownership in the life insurance policy, the death proceeds will be includible in his or her estate • If the spouse is named as beneficiary, the proceeds will qualify for the marital exclusion • If the participant creates an irrevocable life insurance trust, the death proceeds can escape inclusion in the estate