February 2011

Once annual enrollment has come and gone, it’s a good time to brush up on some basic benefit plan requirements, to avoid some of the common mistakes made in employee benefit plan administration. The following list of potential errors is by no means exhaustive, but represents a sampling of issues to steer clear of:

• Keep your plan documents up to date and reference them in related plan communications. ERISA requires that all employee benefit plans be maintained pursuant to a written plan document. As the governing document for the plan, it should be reviewed regularly, and amended if necessary, to keep up with new laws and regulations (such as health care reform). Since this will be the most detailed document regarding any given plan, it should be referenced in disclaimer materials included in less formal plan communications (such as annual enrollment materials) as the document that will control in the event of discrepancies, or errors or omissions in these other ancillary communications.
• Keep summary plan descriptions (SPDs) up to date and distribute them to employees. ERISA requires that employees receive an SPD covering each benefit plan, and specifies the information that must be included in the SPD. Plan vendors might supply booklets or other communications materials to distribute to employees that describe the plan, but these are unlikely to meet the requirements for an SPD. When plan changes result in an SPD needing modification, an employer might distribute a summary of material modifications in the interim before preparing an updated SPD.
• Include only eligible employees (and dependents) in your plans, as to do otherwise will run contrary to plan documents and represent unnecessary coverage costs for your company. Improperly covering ineligible individuals — contractors, leased employees, former employees, etc. — can be a costly proposition. Similarly, maintaining formerly eligible dependents who, for example, have aged out of the plan, unnecessarily adds to plan costs. Eligibility audits can help to mitigate this problem.
• Follow plan terms in administrative practices. The plan document governs, and both internal staff and outside administrators must follow the terms of the plan when making eligibility and claims decisions, issuing plan notices, handling appeals, etc.
• Make sure plan contributions are calculated properly. This includes taking into account the definition of compensation that is in the plan (which might include bonuses, commissions, etc.) and calculating matching and profit sharing contributions correctly.
• If you allow employees to pay for any benefits on a pretax basis, a cafeteria plan is required. Although the term “cafeteria plan” might conjure images of employees selecting from a menu of benefit choices, a cafeteria plan is, at its most basic level, a premium only plan, and is required to be adopted before employees can pay their health (or dental, vision, etc.) plan premiums with before-tax dollars, or to make before-tax contributions to a health care or dependent care flexible spending account.
• If employees make salary deferrals to a 401(k) plan, these deferrals must be deposited into the plan trust on a timely basis, as by DOL regulation they become plan assets as soon as they can be reasonably segregated from the employer’s general assets.
• Review your COBRA administrative practices to make sure all individuals qualified to elect COBRA coverage receive the proper notices, for all plans subject to COBRA (the health plan, but also the dental and vision plan, and the health care flexible spending account).

Administrative errors can result in fines and penalties, lawsuits, and employee discontent. An annual plan self-review can avoid these potential costly consequences of common mistakes.

You have a great group of employees working with you and your business is thriving. You know much of that success is due to one or two key individuals with both skills and personalities that would be difficult to replace. Imagine they were injured and out of work for a while, or even worse, suppose they died unexpectedly? Would your business survive? There are five separate groups that will be most concerned about the immediate financial health and future of the business in the event of the death or disability of an owner or key employee:

• Employees will be concerned about the continuation of the business and their job security.
• Creditors will be worried about the effect of the key employee’s death on the earning power of the business and its future ability to pay back any outstanding debts.
• Suppliers will wonder about the potential loss of a customer.
• Customers will be concerned about the ability of the business to continue providing its products and services, and will consider looking elsewhere to satisfy their needs.
• Tax collectors will be concerned, but only to the extent that there are sufficient funds to pay the necessary taxes, even if it means the ultimate sacrifice of the business.

Key Employee Life and Disability insurance policies can help soften the impact of all of these.

Key Employee Life Insurance. Generally, your business purchases a Life insurance policy on a key employee, pays the premiums and is the beneficiary in the event of the employee’s death. As the owner of the policy, the business may surrender it, borrow against it and use either the cash value or death benefits as the business sees fit.

However, coming up with a dollar value on a key employee’s economic worth can be challenging. There are no specific rules or formulas to follow, but there are several guidelines that can help. The appropriate level of coverage might be the cost of recruiting and training an adequate replacement. On the other hand, the insurance amount might be the key employee’s annual salary times the number of years a newly hired replacement might take to reach a similar skill level. Finally, you might consider the key employee’s value in terms of company profits. The level of insurance coverage might then be tied to any anticipated profit or loss.

Premiums for key employee Life insurance are not a tax-deductible business expense for federal income tax purposes, since your business is the recipient of the benefits. For the most part, the death benefits your company receives as the beneficiary of the policy are not considered taxable income. However, if your business is a C corporation, the death benefits may increase the corporation’s liability for the alternative minimum tax. Consult a tax professional for information on your specific circumstances.

Key Employee Disability Insurance. The death of a key employee isn’t the only threat to your business. What if a key employee is injured or becomes ill and is out of work for an extended period of time? Disability insurance on such a key employee is another way you can protect your business against any resultant financial loss.

A crucial part of key employee Disability insurance policies is the definition of disability. Typically, these policies define disability as the inability of the employee to perform his or her normal job duties due to injury or illness. As with Life insurance, your business buys a Disability insurance policy on the employee, pays the premiums, and is named as the beneficiary. If the employee becomes disabled, the insurance coverage pays monthly disability benefits to your business. These benefits can equal a certain percentage of the key employee’s monthly salary, up to either a maximum monthly limit or 100% of their salary. The benefits may be used to pay the operating expenses of the business and to cover the expense of finding a temporary or permanent replacement for the key employee.

Disability policies typically offer elimination periods (i.e. the waiting period between the disability and when the benefits begin) ranging from 30 days to 365 days. Depending on the policy, your business may receive benefits for six to 18 months, which would be long enough to allow the key employee to return to work or for the company to replace the key employee.

Depending on the type of coverage purchased, the premiums you pay for the key employee Disability policy may or may not be a tax-deductible business expense. If the policy is considered business overhead expense insurance, then the premiums are a deductible expense. Although the business would be responsible for paying taxes on any disability benefits received, the business expenses the policy pays for indirectly would result in an offsetting deduction.

Planning ahead can help secure your company’s financial future by preventing a business from having to liquidate to raise cash. Key employee insurance can help assure families, employees, creditors, suppliers and customers that the future of the business is secure. By purchasing Life and Disability insurance on the owner(s) and/or key employees, the business is letting everyone know the financial condition of the business will remain sound despite the loss of a key person.