How to read a Non-Qualified 401(k) Look-Alike Plan illustration using aggregate funding Non-qualified plans can be a powerful tool for employers to attract and retain key employees. The key employees have another way to adequately save for retirement. And a Non-Qualified 401(k) Look-Alike plan allows them to defer income to a time when they expect lower tax rates. Employers often turn to non-qualified deferred compensation plans as an executive benefit because of the dollar limitations that the Internal Revenue Code (I.R.C.) places on qualified plans. The Code limits the deferral amounts and total plan contributions and also defines maximum allowable compensation. In effect, the limits on contributions have made qualified plans reverse discriminatory. These plans fail to provide the same ratio of before-to-after retirement income for executives as they would for the average worker. Personal savings, Social Security and qualified plans may meet the retirement needs of many workers but more than likely will not be sufficient for today s highly compensated executives. Therefore, highly paid executives are actively seeking a means to replace lost retirement income. This material must be preceded or accompanied by a current Voya Corporate Variable Universal Life prospectus and the entire policy illustration. This material is designed to help you understand how to read a Non- Qualified 401(k) Look-Alike Funded Illustration and to provide general information for use by legal and tax counsel. These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor. The Voya Life Companies and their agents and representatives do not give tax or legal or accounting advice. This information is general in nature and not comprehensive, the applicable laws change frequently and the strategies suggested may not be suitable for everyone. Clients should seek advice from their tax and legal advisors regarding their individual situation. Variable life insurance products are subject to investment risk, are not guaranteed and will fluctuate in value. In addition, there is no guarantee that any subaccount will meet its stated objective. The hypothetical annual returns shown on the following illustration are illustrative only and should not be deemed a representation of past or future rates of return. Individuals should obtain a personalized illustration and review the prospectus carefully before making a purchase decision. Before investing, your clients should carefully consider their need for life insurance coverage and the charges and expenses of the variable universal life insurance policy. They should also consider the investment objectives, risks, fees, and charges of each underlying variable investment option. This and other information is contained in the prospectuses for the variable universal life insurance policy and the underlying variable investment options. Obtain a prospectus for the underlying variable investment options from your registered representative or from voya.com and read it carefully before investing. We have made assumptions in the Non-Qualified 401(k) Look- Alike Plan design and in the insurance policies. References to cash flows, supplemental retirement benefits and future benefits are projected based solely on these assumptions. Actual cash flows, supplemental retirement benefits and future benefits may be different than these projections.
Non-Qualified 401(k) Look-Alike plans provide an attractive opportunity for rewarding valuable executives who need to create additional retirement income. A Non-Qualified 401(k) Look-Alike plan is funded by employee deferrals. Employers may choose to contribute to the plan, and if they do, can put a vesting schedule in place. Benefits from the plan are based on the deferral account growth. The benefit may be structured as a single payment or as a series of payments which typically commence at the executive s retirement or upon the executive s death. The executive does not pay income taxes until the benefits are paid out. Businesses will often purchase a cash value life insurance policy to provide funds that will be needed to pay the promised benefits. These plans are subject to the requirements of IRC 409A and 101(j).* In our example we have an employer with 28 executives who desire to defer some of their income until retirement. The employer has agreed to implement a Non-Qualified 401(k) Look-Alike plan. Here are the 401(k) Look-Alike plan assumptions: 28 executives participating in this plan, ages ranging from 44 to 62. deferrals ranging from $10,246 to $98,361 are made to retirement at age 65. The deferral account balance is assumed to grow at 8% annually. Retirement benefits are projected to start at retirement and last 15 years. The pre-retirement death benefit is the deferral account balance. An employer tax bracket of 40%. Here are the life insurance policy assumptions: Product is Voya Corporate Variable Universal Life insurance, issued by Security Life of Denver Company. The plan is aggregate funded, using an equal premium design. Ages ranging from 44-62, Male and Female, Preferred Non Smoker. Cash Value Accumulation Test. Illustrated rate is 8% (8.65% gross with average fund allocations). A death benefit side fund is shown, assuming a gross rate of return of 4%. Mortality has been assumed at age 90. The policies are funded to remain in force until age 100. The death benefits, ages and level of funding have created a design that qualifies for our Guaranteed Issue underwriting program, so Select Guaranteed Issue, nonsmoker, gender specific rates have been used. Let s review aggregate funding. funding uses the total available funds over the total number of company owned life insurance policies to informally fund the plan. Under the aggregate funding method, the cost of providing benefits to all plan participants is distributed across all of the policies being used to informally fund the benefit plan. In non-aggregate funded Non-Qualified 401(k) Look-Alike plans, the death benefits can be scheduled for cost recovery on each individual. When aggregate funding is used, the cost recovery is also in the aggregate so the death benefit from a specific individual may or may not cover all the benefits needed to be paid at that time. Later in the presentation we will see how the aggregate funding affects cash flows for the sponsoring company when there are early retirees. We have also shown a death benefit side fund in this design, as it can be useful in potentially providing benefits for the younger participants later in the plan. Both these elements can help create a plan that is practical and may be easier to administer than other designs. For an employer sponsoring a Non-Qualified 401(k) Look-Alike plan an important consideration are the plan costs. Most of the costs of a non-qualified plan are reflected in a company s cash flow statement and on their balance sheet. In the Voya Presents Classic Non-Qualified 401(k) Look-Alike illustration, those are reflected on the cash flow and earnings pages. Understanding what the numbers are telling you can be key to making a sale. * IRC 409A limits the permissible events for distributions from a non-qualified retirement plan, imposes requirements for the timing of deferral elections, substantially limits the ability of participants to change the time or form of payments from the plan, and places restrictions on the types of trusts that may be used for informally funding a plan. Failure to satisfy the requirements of IRC 409A will result in the loss of tax deferral, the immediate taxation of all current and previously deferred income under the plan, interest payments, and significant tax penalties. Clients should seek their tax or legal advisors for more information. IRC 101(j) provides that death benefits from an employer-owned life insurance policy are income taxable in excess of premiums paid, unless an exception applies and certain notice and consent requirements are met before the policy is issued. Please consult your tax or legal advisors for more information. Additionally, life insurance owned by a C corporation may result in alternative minimum tax under certain limited circumstances. 2
We will start with the cash flow pages. Here are columns from the cash flow summary for our sample case. Corporate cash flow summary Executive: Valued employee State of issue: Minnesota Deferral account growth rate: 8% Premium allocation: 100% variable investment options at 8.65% Gross hypothetical return cash flow Side fund cash flow Benefit plan cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) ( 12 ) Corporate Premium Net Policy Distributions Net Proceeds Death Benefit at 2.4% Net Retained Cash (Deferral) Projected Benefits to Executives Income Tax Saved/Paid Benefit Plan Cash Flow Net of 1-750,000 0 0-750,000 0 0 750,000 0-300,000 450,000-300,000-300,000 2-750,000 0 0-750,000 0 0 750,000 0-300,000 450,000-300,000-300,000 3-750,000 0 0-750,000 0 0 750,000 0-300,000 450,000-300,000-300,000 4-655,669 0 0-655,669 0 0 673,156-29,145-257,604 386,406-269,262-269,262 5-655,669 0 0-655,669 0 0 673,156-29,145-257,604 386,406-269,262-269,262-3,561,338 0 0-3,561,338 0 3,596,312-58,290-1,415,209 2,122,813-1,438,525-1,438,525 As with many ledgers we start out with the, and the Premium (1). In the insurance cash flow columns, the premiums are a negative number as they are a cost to the company. The next column shows Net Policy Distributions (a combination of loans and withdrawals*) (2), followed by Net Proceeds (3) and column 4 is our. Column 4 is the accumulation of columns 1, 2 and 3. You will notice that in year 4 the premiums reduce. There are two causes for this. Some individuals have retired, and stopped contributing deferrals. In addition, the net after tax cost of the retirement benefit is taken out of the remaining ongoing deferrals. The deferrals can be seen in column 7, which is also referred to as Retained Cash. In year 4 the deferrals drop from $750,000 to $673,156. Retirement benefits in the amount of $29,145 begin. If you take the net after tax cost of those benefits, $17,487, and subtract that from $673,156, you get the premium amount of $655,669. Now let s take a look at the Benefit Plan columns. These start with column number 7 and go through column number 11. Column number 7 is called Retained Cash (Deferral). When an executive defers income, the income stays with the company, and so it is retained. The company may decide to spend it, but for purposes of accounting, compensation due an employee has been kept. The number is a positive one, as it adds positive cash flow to the company. Column 8 shows the benefits that are projected to be due the executive. We will look more closely at that column later on. Column 9 is titled Income Tax Saved/Paid. When a company pays out compensation to an employee, that payment is generally deductible. In the case of a company with a 40% tax bracket, when employees choose to defer $750,000 in a non-qualified plan, the company loses a tax deduction, and therefore has paid $300,000 ($750,000 x 40%) more in tax, than if the employee took the income. Similarly, at the time benefits are paid, a deduction is taken, which results in a savings to the company. Column number 10 is the accumulation of columns 7, 8 and 9. Column 11 is column 4 plus column 10. * Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered). 3
What happens in future years? cash flow Side fund cash flow Benefit plan cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) ( 12 ) Corporate Premium Net Policy Distributions Net Proceeds Death Benefit Side Fund at 2.4% Net Retained Cash (Deferral) Projected Benefits to Executives Income Tax Saved/Paid Benefit Plan Net of Side Fund 26 0 1,118,280 0 1,118,280 0 0 0-1,863,800 745,520-1,118,280 0 0 27 0 1,082,415 0 1,082,415 0 0 0-1,804,025 721,610-1,082,415 0 0 28 0 1,041,526 1,218,356 2,259,282 0 0 0-1,735,877 694,351-1,041,526 1,218,356 1,218,356 29 0 0 0 0 1,216,356 916,476 0-1,527,461 610,984-916,476-916,476 0 30 0 555,177 1,109,206 1,664,383 309,125 309,125 0-1,440,503 576,201-864,302 864,302 1,109,206-6,773,538 11,418,960 2,327,562 6,971,059 1,225,601 9,562,502-25,722,540 6,464,015-9,696,022-2,723,039-1,497,438 Let s look at the s first. The deferrals have stopped, and so have the premiums, so the annual premium column (1) has become zero, although the total premium outlay shows up in the total lines. Column 2 has now become a positive number because funds are coming out of the policy, via loans and withdrawals,* and back into the company. The first death proceeds are projected to arrive at the end of year 28. Column 4 is the total of columns 1, 2 and 3. Looking at the Benefit Plan, since the deferrals have stopped the retained cash column (7) is now zero, although again the total of the money previously retained shows up appropriately. The benefits projected to the employees (8) are $1,863,800 a year. Column 9 is now positive. In year 26, when the benefit of $1,863,800 is paid out, the company gets to take a tax deduction of $745,520 ($1,863,800 x 40%) which it considers a savings. Column 10 reflects the benefit plan s cash flow, which is the after tax cost of the retirement benefit, or -$1,118,280 (-$1,863,800 plus $745,520). Column 11 in year 26 is now at zero. Remember, column 11 is column 4 plus column 10. Since the distributions from the life insurance policy are equal to the after tax cost of the benefits, the cash flow effect of the informally funded plan is now at zero. The first death benefit is projected to be received at the end of year 28. In year 29, the net after tax cost of the retirement benefits (see column 10) is -$916,476. The illustration assumes that the death benefits are set aside in a fund to be used to pay ongoing benefits. In year 29, the -$916,476 from column 10 is taken from the side fund. Since it comes out of the side fund, it is reflected as a negative outlay in column 11. But also since it came from the side fund, the aggregate after tax cash flow of the plan including that fund (column 12) is 0. You will notice that the side fund is assumed to grow at net rate 2.4%. The illustration assumes the death benefits are placed in a liquid investment paying a low pre-tax rate of 4%. The after tax return assuming a 40% tax bracket is therefore 2.4%. The initial death benefit goes into the fund. The net after tax cost of retiree benefits is paid out of it and the remainder grows at a net 2.4%. ($1,218,356 minus $916,476 is $301,880. $301,880 times 1.024 equals $309,125.) In year 30 the total net after tax cost of the benefits (column 10) is -$864,302. First the $309,125 in the side fund is applied and the remaining $555,177 is taken out of the policies via loans and withdrawals.* * Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered). 4
The information that affects a company s balance sheet is on the earnings pages. Let s start with the first few years of the report called: Corporate impact on earnings summary Policy issue date: 01/01/2016 earnings impact Benefit plan earnings impact ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) Premiums, Withdrawals, Gross Proceeds Gross Cash Surrender Value Increase Policy Loan Interest Accrued * Earnings Impact Compensation Expense Deferred Tax Savings** Net Effect on Retained Earning Benefit Plan After Tax Impact After Tax Impact 1-750,000 745,032 0-4,968-810,000 324,000 450,000-36,000-40,968 2-750,000 769,527 0 19,527-874,800 349,920 450,000-74,880-55,353 3-750,000 795,212 0 45,212-944,784 377,914 450,000-116,870-71,658 As in the cash flow report, the premium costs (1) are shown as a negative number. But the annual cash value increases starting in year two (2) are positive, as they are an asset of the sponsoring company. Since the annual cash value increases in this illustration are greater than the premium costs, the Earnings Impact (4) is positive starting in year two. The Compensation Expense is the total increase in liability each year that the company has for the plan. In year one there are $750,000 of deferrals. The projected benefit rate in this illustration is 8%. Consequently, in year one the total expense is the actual deferred amounts plus 8% ($750,000 plus $60,000) or $810,000. In the second year we add the initial balance of -$810,000 from the prior year to the current contribution expense of -$750,000 and multiply that again by 8%. This gives us the annual interest expense of -$124,800. Thus, the second year Compensation Expense is -$874,800 (the interest expense plus the current year s $750,000 contribution). Although the company cannot take a tax deduction on the funds deferred, they concluded they can recognize a tax deduction on their balance sheet. This is called the Deferred Tax Savings (6). It is a savings as it is considered a positive asset that offsets the Compensation Cost. The Deferred Tax Savings is equal to the Compensation Expense times the company s current tax bracket (which is assumed to be 40% for our sample illustration). Column 8 is the sum of columns 5 through 7. Column 9 is the combination of column 4 and column 8. * Please note that these results are based on current assumptions and a hypothetical net rate of return of 8% and are not guaranteed. Assuming the Maximum Guaranteed Policy Costs and a zero Gross Hypothetical Return the first year cash surrender value is only $738,218, resulting in a negative entry in column 4. ** This illustration assumes that, the employer concluded that, more likely than not, the employer will be eligible to use the offset in the future (FAS 109). This illustration also assumes that no deferred tax liability must be recorded with respect to differences between premiums paid and cash surrender values because the policy will be held until death. 5
In this illustration the first retirement benefits are projected to start in year four. So beginning in that year some executives compensation expenses are growing and some are decreasing. To understand how those numbers work, let s look at a sample individual. Let s take a look at the first three columns of the earnings detail which is found on the page titled: Corporate impact on earnings benefits only Executive: Valued employee State of issue: Minnesota Deferral account growth rate: 8% ( 1 ) ( 2 ) ( 3 ) End of Age Total Contributions Interest Cost Compensation Expense 1 56-10,000-800 -10,800 2 57-10,000-1,664-11,664 3 58-10,000-2,597-12,597 4 59-10,000-3,605-13,605 5 60-10,000-4,693-14,693-50,000-13,359-63,359 As mentioned earlier, the executive s account growth rate is projected to accrue at 8%. When looking at the company s costs we have to account for the interest that accrues each year on the executive s account, plus the funds that are contributed to the plan. This is not just an accounting requirement, but a reflection of the liability the company actually has. The Total Contributions are equal to the $10,000 annual deferrals. Although the contributions are not yet paid, they are owed to the executive and consequently are shown as a negative number. Assuming an 8% rate of growth the first year interest cost is 8% times -$10,000, or -$800.00 (column 2) creating a total first year Compensation Expense of $10,800 (column 3). In the second year we add the initial balance of -$10,800 from the prior year to the current contribution expense of -$10,000 and multiply that again by 8%. This gives us the annual interest expense of -$1,664. Thus, the second year Compensation Expense is -$11,664 (the interest expense plus the current year s $10,000 contribution). After five years our total compensation expense for the plan is -$63,359. That same $63,359 is what is due the executive, should he or she leave the company, after five years. 6
Now let s look at what happens once benefits are being paid. Corporate impact on earnings benefits only Executive: Valued employee State of issue: Minnesota Deferral account growth rate: 8% Executive summary ( 1 ) ( 2 ) ( 3 ) ( 3 ) End of Age Total Contributions Interest Cost Compensation Expense Total Account Balance 11 66 0-11,162-11,162 12 67 0-10,701-10,701 13 68 0-10,204-10,204 14 69 0-9,666-9,666 15 70 0-9,085-9,085-100,000-107,273-207,273 150,693 144,470 137,749 130,490 122,651 To explain the decreasing Interest Costs and decreasing Compensation Expense, we will borrow a column, The Executive Summary, a report that comes later in the illustration. In year 11, retirement has begun. The executive s account balance has been growing up to this point, both by annual contributions and assumed interest. Starting at retirement, in our illustration year 11, there are no further contributions. Retirement benefits in the amount of $16,925 begin. Assumed interest continues to be paid on the remaining balance, but since the balance is decreasing so does the interest and therefore the expense to the company. At retirement the end of year Total Account Balance owed the executive is $156,455. The retiree is paid $16,925. The interest cost is the balance of $156,455 less the retirement benefit of $16,925 times 8% or $11,162. 7
As you can see, when we look at a composite report, we have the combination of all individual accounts. Corporate impact on earnings summary Policy issue date: 01/01/2016 earnings impact Benefit plan earnings impact ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) Premiums, Withdrawals, Gross Proceeds Gross Cash Surrender Value Increase Policy Loan Interest Accrued * Earnings Impact Compensation Expense Deferred Tax Savings** Net Effect on Retained Earning Benefit Plan After Tax Impact Impact 1-750,000 745,032 0-4,968-810,000 324,000 450,000-36,000-40,968 2-750,000 769,527 0 19,527-874,800 349,920 450,000-74,880-55,353 3-750,000 795,212 0 45,212-944,784 377,914 450,000-116,870-71,658 4-655,669 726,729 0 71,061-935,044 374,017 403,894-157,133-86,072 5-655,669 751,380 0 95,711-1,007,515 403,006 403,894-200,616-104,905-3,561,338 3,787,881 0 226,543-4,572,143 1,828,857 2,157,787-585,499-358,956 Why is there so much emphasis on the earnings impact of a Non-Qualified 401(k) Look-Alike plan? As you probably know, a healthy balance sheet is critical for businesses that need to raise capital for projects, or expansion. It is also important for firms that are required to post bonds. The negative earnings impact shows up on the company s balance sheet as a liability. That is why the potential for strong cash surrender values, as is available in Voya Corporate VUL, is important. These values are listed as an asset on the balance sheet and so offset some of the plan costs. * Please note that these results are based on current assumptions and a hypothetical net rate of return of 8% and are not guaranteed. Assuming the Maximum Guaranteed Policy Costs and a zero Gross Hypothetical Return the first year cash surrender value is only $738,218, resulting in a negative insurance after tax earnings impact. ** This illustration assumes the employer concluded that, more likely than not, the employer will be eligible to use the offset in the future (FAS 109). This illustration also assumes that no deferred tax liability must be recorded with respect to differences between premiums paid and cash surrender values because the policy will be held until death. 8
We ve mentioned several times that this is an aggregate funded plan. Our Voya Presents Classic illustration includes an Funding Summary that can help you understand how the plan is working. funding summary Policy issue date: 01/01/2016 cash flow Side fund cash flow funding cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) ( 12 ) ( 13 ) Total Contributions Retirement Benefits Corporate Premiums Net Policy Distributions Net Proceeds Death Benefit Side Fund at 2.4% Net Column 1 is the total contributions. It decreases in year 4 due to participants retiring. Column 2 is the after tax cost of the projected supplemental retirement benefits payable. Column 3 is the insurance premiums, column 4 reflects any loans and/or withdrawals* and column 5 is the net proceeds at death. Column 6 is the total of columns 1 through 5. When death benefits start they will show up in column 7. The illustration assumes that they would be invested in a very conservative and liquid investment vehicle until used. With a gross rate of return of 4% and a 40% tax bracket the net return on those funds would be 2.4%. Column 8 reflects the cash flow of the funds being used from the side fund. We ll look at that closer in the next section. Column 9, the Target Funding Amount, is the amount that needs to be aggregately distributed among the existing life policies. In year 21 the last contribution of $46,107 is made. The after tax cost of the retirement benefits is $1,075,178. Consequently, the Target Funding Amount is $1,075,178 less $46,107 or $1,029,071. The Funding Variance (column 10) is the difference between the Target Funding amount and the combined After Tax and. A positive variance is a shortfall and a negative variance is a gain. That is because a positive number means the company has added funds to the plan, and a negative number in that column means there is excess cash flow to the plan from the death benefits. As you can see in year 21, the insurance cash flow from the life policies is equal to the funds needed to pay benefits, and therefore the Funding Variance is 0. In year 21, the benefit plan after tax cash flow is the combination of the contributions (1) and the after tax cost of the retirement benefits (2). The (column 12) is the combination of column 6 and column 11. Column 13 is the total of all three cash flow columns (6, 8 and 11). * Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered). Side Fund Cash Flow Target Funding Amount Funding Variance Benefit Plan Cash Flow Net of 1-750,000 0-750,000 0 0-750,000 0 0 750,000 0 450,000-300,000-300,000 2-750,000 0-750,000 0 0-750,000 0 0 750,000 0 450,000-300,000-300,000 3-750,000 0-750,000 0 0-750,000 0 0 750,000 0 450,000-300,000-300,000 4-673,156 17,487-655,669 0 0-655,669 0 0 655,669 0 386,406-269,262-269,262 cash flow Side fund cash flow funding cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) ( 12 ) ( 13 ) Total Contributions Retirement Benefits Corporate Premiums Net Policy Distributions Net Proceeds Death Benefit Side Fund at 2.4% Net Side Fund Cash Flow Target Funding Amount Funding Variance Benefit Plan Net of 21-46,107 1,075,178 0 1,029,071 0 1,029,071 0 0-1,029,071 0-1,047,514-18,443-18,443 22 0 1,238,143 0 1,238,143 0 1,238,143 0 0-1,238,143 0-1,238,143 0 0 9
Next we ll take a look at what happens when the projected deaths begin. cash flow Side fund cash flow funding cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) ( 12 ) ( 13 ) Corporate Total Retirement Net Policy Contributions Benefits PremiumsDistributions Net Proceeds Death Benefit Side Fund at 2.4% Net Side Fund Cash Flow Target Funding Amount Funding Variance Benefit Plan After Tax Cash Flow Net of 28 0 1,041,526 0 1,041,526 1,218,356 2,259,282 0 0-1,041,526-1,218,356-1,041,526 1,218,356 1,218,356 29 0 916,476 0 0 0 0 1,218,356 916,476-916,476 0-916,476-916,476 0 30 0 864,302 0 555,177 1,109,206 1,664,383 309,125 309,125-864,302-1,109,206-864,302 800,081 1,109,206 In year 28 the after tax cost of the retirement benefits (2) is $1,041,526, and $1,041,526 is taken via loans and withdrawals* from the life policies (4). In addition, there are net proceeds at death of $1,218,356. For the purposes of illustrating this concept, we assume the death benefits are received at the end of the year. The insurance after tax cash flow (6) is the combination of the policy distributions (4) and the net proceeds at death (5). The aggregate funding amount (9) is equal to the policy distributions (4). The aggregate funding variance is the death benefits that have been received at the end of the year. This provides the company with a positive aggregate after tax cash flow of $1,218,356. In year 29 the death benefits are moved into the side fund. For illustrative purposes it is assumed this happens at the beginning of year 29. The cost of the after tax retirement benefits in year 29 (2) is now $916,476. This amount is taken from the side fund (see column 8). This year our aggregate funding target is that same $916,476 so the variance (10) is zero. The benefit plan cash flow and aggregate cash flow amounts are the same: -$916,476. However, those funds were provided by the death benefit side fund, so the Net of (column 13) is zero. In year 29 the company put $1,218,356 into a side fund. Then the company paid the $916,476 out of that fund. The fund is growing at 4% gross (2.4% net) so in year 30 there is a side fund balance of $309,125. In year 30 the net after tax cost of retirement benefits is $864,302. The company pays $309,125 out of the side fund and uses policy distributions of $555,177 to pay the rest of the costs. Death benefits are received at the end of the year in the amount of $1,109,206 (column 5). The aggregate after tax cash flow (12) is the combination of the insurance cash flow of $1,664,383 and the benefit plan cash flow -$864,302. Since the benefit plan cash flow was paid for from the side fund and the policy distributions the aggregate after tax cash flow net of the side fund is $1,107,242 (i.e. the net proceeds at death for that year). * Policy loans and partial withdrawals may vary by state, reduce available surrender value and death benefit or cause the policy to lapse. Generally, policy loans and partial withdrawals will not be income taxable if there is a withdrawal to the cost basis (usually premiums paid), followed by policy loans (but only if the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered). 10
Voya Presents Classic includes a report on the side fund itself. Death benefit side fund detail Policy issue date: 01/01/2016 Side fund cash flow funding cash flow ( 1 ) ( 2 ) ( 3 ) ( 4 ) ( 5 ) ( 6 ) ( 7 ) ( 8 ) ( 9 ) ( 10 ) ( 11 ) Retirement Benefits Net Proceeds Death Benefit Side Fund at 2.4% Net Benefit Paid From Side Fund Balance Benefit Plan Cash Flow Net of Net Cash Surrender Value # of Active Policies 28 1,041,526 1,218,356 0 0 0 2,259,882-1,041,526 0 1,218,356 10,666,983 28 29 916,476 0 1,218,356 916,476 309,125 0-916,476 916,476 0 10,138,767 26 30 864,302 1,109,206 309,125 309,125 0 1,664,383-864,302 309,125 1,109,206 10,080,368 26 This report provides more detail on the side fund itself, including showing the benefits paid from the side fund. In addition, you can see the cash surrender values, and the number of policies being used for the aggregate funding in each year. 11
The last report we will look at is the Executive Summary. The Executive Summary is one of the individual reports you can request when running an aggregate funded Non-Qualified 401(k) Look- Alike Illustration. Executive summary State of issue: Minnesota Deferral account growth rate: 8% ( 1 ) ( 2 ) ( 3 ) ( 4 ) End of Age Deferred Income Total Account Balance Projected Benefits to Executive Total Survivor Benefit Payable 1 56 10,000 10,800 0 10,800 2 57 10,000 22,464 0 22,464 3 58 10,000 35,061 0 35,061 4 59 10,000 48,666 0 48,666 5 60 10,000 63,359 0 63,359 (We ll skip the next five years ) 11 66 0 150,693 16,925 150,693 12 67 0 144,470 16,925 144,470 13 68 0 137,749 16,925 137,749 14 69 0 130,490 16,925 130,490 15 70 0 122,651 16,925 122,651 These numbers may look familiar. The increasing account balance (2) ties in to the earnings charges that have to be accounted for by the company. While the executive is deferring income, the balance grows in his or her account, in this illustration by a hypothetical rate of 8%. Once the benefit is being paid, the account balance is reduced, but the balance remaining continues to be credited with any interest due. Earlier the point was made that the owners of the company need to know what costs they can expect from implementing this type of plan. Participants also need to know how it can benefit them, as this report clearly shows. In addition, if one of the key decision makers is going to participate in the plan, this report can be very useful in selling this design. 12
Hopefully this document has helped you understand our Non-Qualified 401(k) Look-Alike Illustrations Using Funding. It has probably become clear insurance contracts with the potential for strong cash surrender values are very important to a company implementing this kind of plan, as they may be able to offset the charge to earnings that will go on a company s balance sheet. In our example we assumed current policy costs, a gross hypothetical rate of 8.65% and average fund allocations. This resulted in projected positive earnings to the company as early as the first year. Keep in mind, variable insurance products are subject to investment risk, are not guaranteed and will fluctuate in value. The hypothetical example shown is for illustrative purposes only and should not be deemed representative of past or future rates of return. Making it easier The Voya Life Companies have created a platform to help make Executive Benefits easier for you. To learn more, try any of the following materials: Sales materials Ā Ā Executive Benefits Producer Guide (#140181) An overview of Executive Benefits and the different plan designs that can be used to help employers recruit, retain, and reward key employees and executives. Ā Ā Executive Benefits Client Brochure (#140220) An overview of Executive Benefits and plan designs that you can give to clients. Ā Ā Non-Qualified 401(k) Look-Alike Producer Guide (#116712) An overview of Non-Qualified 401(k) Look- Alike plans using life insurance. Ā Ā Non-Qualified s with Life : Exceptional Executives Deserve Exceptional Benefits (#116713) For employers, this consumer brochure explains benefits of rewarding their top talent with a 401(k) Look-Alike plan. Ā Ā Non-Qualified s with Life : You Know What You re Worth. So Does Your Employer (#116715) For employers, this consumer brochure explains benefits of rewarding their top talent with a 401(k) Look-Alike plan. To find these as well as additional materials and information, go to the Executive Benefits page on Voya for Professionals, the Executive Benefits microsite at VoyaExecutiveBenefits.com or call Advanced Sales at 866-464-7355, Option 4. 13
The Voya Life Companies and their agents and representatives do not give tax or legal or accounting advice. This information is general in nature and not comprehensive, the applicable laws change frequently and the strategies suggested may not be suitable for everyone. You should seek advice from your tax and legal advisors regarding your individual situation. Voya Corporate Variable Universal Life [Form Series #2516 (VUL)-09/07], may vary by state and may not be available in every state (not available in New York), is issued by Security Life of Denver Company (Denver, CO) and is distributed by Voya America Equities, Inc. Both are members of the Voya family of companies. Variable insurance products are subject to investment risk, are not guaranteed and will fluctuate in value. In addition, there is no guarantee that any variable investment option will meet its stated objective. 2016 Voya Services Company. All rights reserved. CN 0111-21031-0218 151933 02/01/2016 Voya.com