Funding of Deferred Compensation Plan:
Purchase of Life Insurance Under BCA DCP

This Memorandum will respond to the many questions we have received regarding the use of life insurance and annuities to fund benefits under the Benefits for Corporate America, Inc. Deferred Compensation Plan ("BCA DCP").


The BCA DCP is a non-qualified deferred compensation arrangement for executives (Key and Highly-Compensated Employees) only. As such, it is not subject to ERISA and does not receive tax-exempt status under the Internal Revenue Code ("IRC").

For many purposes it operates similar to a discriminatory §401(k) plan: (1) employee salary deferral contributions are subject to FICA and Medicare taxes, but not to income taxes; (2) the employee has the ability to select the investments (within applicable limits); and (3) distributions from the plan are subject to income taxes but not to FICA and Medicare taxes.

§401(k) plans, however, have the ability to invest in any investments without regard to the tax consequences because IRC §501 grants the trust tax exempt status on condition that the plan comply with the non-discrimination (and other) requirements of IRC Section 401. Non-qualified plans do not enjoy the privilege of investing tax-free in any number of investments.

Another difference between qualified plans and non-qualified plans: contributions to qualified plans (such as §401(a) and §401(k) plans) are tax-deductible to the employer within the limits provided under IRC § 404. Generally, deferred compensation arrangements are not tax-deductible to the employer until such benefits are distributed or "made available to" (by vesting) the employee.

By using the BCA DCP, BCA provides funds to the employer to pay taxes on contributions made to the deferred compensation plan. BCA is reimbursed for this loan when the executive retires or becomes fully vested several years down the road at which time the employer receives a tax deduction for the deferred compensation payment. In the meantime, 100% of the employer's and employee's contributions have been invested and growing.


In funding the BCA DCP, BCA must consider all of the foregoing concerns and provide appropriate investments that will:

(1) Permit the employee to select his or her own investments;

Unlike under a 401(k) plan where an employee may be able to control his own investments, IRS has held consistently that an employee may not have control over his account in a deferred compensation plan. To permit such control, in IRS' view, would create the implication that the employee is immediately vested in the account and would require that the employee therefore pay tax on the funds immediately.

Instead, IRS has permitted such arrangements to permit employees to indicate their choice of investments and for the trustee and administrator to take that selection into account when making the investment on behalf of the employee. This is what is done under the BCA DCP.

(2) Obtain tax-advantaged investment growth or income;

Without the ability to use a tax-exempt trust to shelter income and other gains, the BCA DCP, like other deferred compensation plans and taxable trusts, must consider the taxability of all investments. Tax-exempt investments include: (1) municipal bonds; (2) life insurance policies, and (3) annuities. In addition, the plan may use tax-deferred investments such as real estate or stocks and bonds that are never sold and on which the gain is never realized (several mutual funds operate this way).

(3) Make the entire investment account value (including investment returns) available upon the employee's elected retirement date or death, if earlier;

Deferred compensation rules are governed under Section 409A of the IRC and permit distributions upon the properly-elected retirement date or upon the employee's death prior to such date. The plan must, therefore, have sufficient amounts available on such dates to payout all benefits due in full. If investments are purchased which have surrender penalties, those must be gone by the benefit due date or BCA will lose money in its operation of the plan.

(4) Provide commissions to allow BCA's parent to cover the cost of providing funds for the employer's taxes.

The cost of paying taxes today and obtaining a deduction several years down the road is a timing problem: What is the cost of tying up those funds for a few years? Such cost is equal to the interest on a loan obtained by using the executive's investments as collateral.


BCA's investment philosophy is as follows. The ideal investment:

  • would go up in good markets based on measurable investment or market performance;
  • would not go down in years when the market is down; and
  • would not risk investment principal.

Ideally this could be accomplished by purchasing high-grade bonds which are held to maturity with 95+% of the assets and by purchasing call options on the desired stock, fund or index for the investment selected by the employee with the balance. Calls are not available for all investments, but they are available for enough stocks, funds and indexes to accomplish our stated investment objectives and still permit employees a wide range of investment choices.

Unfortunately, it is impossible to obtain an after-tax rate of return on taxable investments equal to the after-tax rate of return on non-taxable investments. If an employee desires a rate of return based on the increase in the S&P 500, a mutual fund which "tracks" the S&P 500 would not work because it would be taxable within our trust.

The only tax-advantaged investments which successfully provide the investment performance required to meet the employee's desired investment objective are variable annuities and life insurance policies which wrap stocks, bonds and mutual funds. And those contracts go down as well as up with the underlying investment. We, therefore, have chosen to use indexed annuities and life insurance contracts that guarantee minimum performance (based on their bond portfolio and purchase call options on investments and market indexes. However, such contracts require 5 years or more before the surrender penalty is gone. In order to mitigate the negative effect on those who want to retire in as short a time as possible, we have agreed to guarantee that no surrender charges will be applied for participants who retire after at least 5 years of participation.


Some employees are not insurable or are insurable only at very expensive rates. For those employees we have no choice but to use annuities. For those employees who are insurable, however, the determination of life insurance versus annuity investment must consider the following:

  • Annuities generally have lower front-end expense charges (and surrender charges) than life insurance policies.
  • Life insurance policies provide greater benefits upon the death of an insured than annuities do on an annuitant's death.
  • On-going expense charges are typically similar between the two types of contracts.
  • Insurance policies pay higher commissions on so-called "target" premiums and lower commissions on "excess" premiums. Annuities pay a flat amount of commission that is higher than the commission rate on excess premiums but lower than on target premiums.

Because a significant number of our clients are rated or uninsurable, our funding policy calls for underwriting all employees and using life insurance policies, appropriately balanced between "target" and "excess" premiums, to obtain the stated goals on those employees who are insurable. It is our funding policy, therefore, to apply for the minimum death benefit that meets our criteria. That death benefit amount determined by: (1) the age of the employee (the younger the higher); (2) the employee's insurability status (less death benefit for rated and smokers); (3) the amount of salary deferral election (more is greater), and (4) the number of years remaining until the employee's retirement date. We assume that contributions will continue at a minimal target premium rate unless otherwise advised, and fund for a non-Modified Endowment Contract over the first 7 years of the policy.