For the education of producers/brokers only. Not for use with the public.1 Single Employer Welfare Benefit Plans This training material has been prepared by the Marketing Staff of Prudential Financial to assist our licensed financial professionals. It is designed to provided general information in regard to the subject matter covered. It should be used with the understanding that Prudential Financial is not rendering legal, accounting or tax services. Such services should be provided by the client’s own advisors. Prudential’s sole role with regard to any 419 arrangement is that of a product provider. Prudential is not providing the 419 concept. Prudential shall not have any involvement, not even as a product provider only, with regard to multi- employer 419A(f)(6) plans. Additionally, Prudential is neither endorsing the use of the 419 strategy nor the use of any 419 concept sponsor. Prudential Financial and the Rock logo are registered service marks of The Prudential Insurance Company of America and its affiliates. The Prudential Insurance Company of America, 751 Broad Street, Newark, NJ, IFS – A Ed. 02/04 Exp. 08/05 Hit Esc

For the education of producers/brokers only. Not for use with the public.2 What It Is Not …  A retirement income plan  A 419A(f)(6) ten or more … Multiple Employer Welfare Benefit Trust

For the education of producers/brokers only. Not for use with the public.3 What it Is …  A single employer plan under IRC §§ 419 and 419A used to provide welfare benefits to employees and their dependents  Governed by different tax rules than the multiple employer plan  A welfare benefit plan subject to ERISA rules

For the education of producers/brokers only. Not for use with the public.4 What it Can Provide …  Welfare benefits: such as disability, medical expenses, severance, supplemental unemployment benefits (SUB) and life insurance  For the plan sponsor: current tax deductions (within limits)  For participants: Tax favored or tax-free benefits when received under IRC §§ 79, 101(a), 105, 106

For the education of producers/brokers only. Not for use with the public.5 The Need … Post Retirement Medical Costs  Employee Benefit Research Institute Issues Brief, February 2003  Medical costs are escalating  Individual w/o access to employment- based health benefits who have Medigap coverage will need to have saved between $47,000 - $1,458,000, to retire at age 65 in 2003.

For the education of producers/brokers only. Not for use with the public.6 What Benefits Are Most Popular?  Retirement medical benefits  Medical co-pays, deductibles, etc.  Prescriptions & “over the counter” meds  Nursing home & home health care costs  Etc.  Life insurance  Single life  Survivorship

For the education of producers/brokers only. Not for use with the public.7 “Where’s The Beef” What’s In It For The Producer?  For income tax reasons the funding of the reserve to provide for post retirement life and health care benefits is often done with a combination of life insurance and other investment products

For the education of producers/brokers only. Not for use with the public.8 In This Presentation …  Income tax rules  Identifying the market  Funding the liabilities  Plan administration

For the education of producers/brokers only. Not for use with the public.9 Employer Tax Treatment …  IRC §§ 419 and 419A: deductible employer contributions for any tax year is limited to the plans “qualified cost”  The annual Qualified Cost for the year, has three components:  Qualified direct cost PLUS  The amount that may be added to the qualified asset account MINUS  The after-tax income of the fund.

For the education of producers/brokers only. Not for use with the public.10 Employer Tax Treatment Qualified Direct Cost …  The total amount (including administrative expenses)  which would have been allowed as a deduction to the employer if such benefits were provided directly by the employer and  the cash method of accounting was used

For the education of producers/brokers only. Not for use with the public.11 Employer Tax Treatment Qualified Asset Account (QAA)…  A reserve set aside to fund for claims for certain types of benefits that were incurred, but not paid for the tax year  Reserves may be set aside for: disability, medical benefits, supplemental unemployment benefits, severance pay, or life insurance  Additions to the qualified asset account are not deductible to the extent they exceed the “Account Limit” under IRC § 419A

For the education of producers/brokers only. Not for use with the public.12 Employer Tax Treatment Qualified Asset Account Limit …  The amount that is“reasonable and actuarially necessary” to fund claims incurred but unpaid plus any related administration expenses as of the close of the tax year  The account limit may include an additional reserve to provide covered employees post retirement medical and life insurance benefits.

For the education of producers/brokers only. Not for use with the public.13 Employer Tax Treatment Post Retirement Medical & Life  Must be funded over the working lives of the covered employees and must be actuarially determined on a level basis using reasonable assumptions i.e. the reserve with respect to an employee can be fully funded no earlier than upon retirement of that employee  This favors older and married employees  Must be nondiscriminatory (IRC § 505(b))  Separate accounts required for each key employee

For the education of producers/brokers only. Not for use with the public.14 Employer Tax Treatment Post Retirement Medical & Life  No discrimination: IRC §505(b)  Neither the classification of employees covered under the plan nor  The benefits provided can discriminate in favor of highly compensated individuals

For the education of producers/brokers only. Not for use with the public.15 Employer Tax Treatment Post Retirement Medical & Life  Separate accounts required for each key employee; benefits provided with respect to that key employee must be paid from this account  Amounts attributable to medical benefits allocated to a key employee’s account are treated as an annual addition to a qualified defined contribution plan for purposes of the dollar limitation  100% penalty applies if post retirement medical or life insurance benefits are discriminatory or not made from separate accounts maintained for key employees

For the education of producers/brokers only. Not for use with the public.16 Employer Tax Treatment Post Retirement Medical & Life  Key Employee Definition IRC § 416(i)  A present or former employee who at any- time during the plan year or any 4 preceding years, is or was:  An Officer earning more than $130,000  A more-than-5% owner  A more-than-1% owner earning over $150,000  One of ten largest owners whose compensation exceeds the annual addition limit for defined contribution plans

For the education of producers/brokers only. Not for use with the public.17 Employer Tax Treatment Reduction For After-Tax Income …  Any after-tax income reduces the qualified direct costs and additions to the qualified asset account (deductible contributions)  After-tax income is the gross income of the fund reduced by the sum of the  Deductions allowed by the Code connected to the production of such income, and  The income tax imposed on the fund  Reason to fund the reserve with tax-free or tax-deferred assets such as life insurance.

For the education of producers/brokers only. Not for use with the public.18 Employer Tax Treatment Excess Contributions  If the employer’s contributions exceed the qualified costs for the fund’s year:  Excess contributions are carried forward to successive years until deductible  Non-exempt Trusts: Excess is considered gross income which reduces contributions and treated and taxed as “deemed” UBIT  Exempt trusts: excess is subject to unrelated business income taxation (UBIT)

For the education of producers/brokers only. Not for use with the public.19 Tax Treatment of Participants …  Income tax treatment is dependent on the type of benefit received  Medical Benefits  IRC §§ 105,106: Employer contributions to the plan are not taxable to the employee when made  IRC §§ 105,106: Post retirement medical benefits are received income tax free when paid from the plan

For the education of producers/brokers only. Not for use with the public.20 Tax Treatment of Participants …  Income tax treatment is dependent on the type of benefit received  Life Insurance  Employer contributions to the plan are taxed under IRC § 79  No taxable income for the first $50,000  Coverage in excess of $50,000 results in taxable income using Table 2001 values  Death benefits are generally excluded from the beneficiary’s income under IRC § 101(a)

For the education of producers/brokers only. Not for use with the public.21 Eligible Business Entities  Most employers, except sole proprietors (Sole proprietors with W-2 employees may be eligible)  Tax treatment of benefits may vary depending on the type of employer entity

For the education of producers/brokers only. Not for use with the public.22 Must All Employees Participate?  Normal ERISA employee exclusion rules apply  70% of employees must be covered  Exclude: employees with less than 36 months of service  Exclude: employees younger than 25  Exclude: employees working less than 35 hrs per week

For the education of producers/brokers only. Not for use with the public.23 Vesting of Benefits Will All Employees Benefit?  Employer must establish an entitlement date which must apply equally to all employees; However  No required minimum vesting schedule  Result: entitlement dates often require a number of years of service  Result: employee who terminates employment prior to entitlement date does not acquire a benefit  Result: effective golden handcuff

For the education of producers/brokers only. Not for use with the public.24 Case Study: Facts  Annual contribution of $100,000 for 5 years in a combination of life insurance and annuities. Benefit Marital Participants Age Age Status Orthodontist - Denny 55 60M Hygienist – Jane M Hygienist – Julie S Hygienist – Marie 30 * 61*M Bookkeeper – Brook 43 68* M * 3 years of service required before participation begins; 33 years of service required before post- retirement benefits are payable. * 3 years of service required before participation begins; 33 years of service required before post- retirement benefits are payable.

For the education of producers/brokers only. Not for use with the public.25 Case Study: Summary Results  Result: Most of the contribution will legally favor employees who are older have higher incomes and dependent status Benefits: Contribution% Benefit Fund* Ins Face Amt. Denny85$304,000 $ 2,000,000 Jane 9$204, ,000 Julie 2$102, ,890 Marie 0 $ 0 0 Brook 4$204, ,000 * The benefit fund represents the amount available to pay post retirement medical benefits after 5 years and represents the cash value of the life insurance and other investments.

For the education of producers/brokers only. Not for use with the public.26 Prospects Who Should Be Interested?  Employers who see the need for additional retirement benefits for themselves, their employees and any dependents  Employers who desire to purchase life insurance with pre-tax dollars  Employers who seek protection from claims of business creditors  Profitable business seeking tax deductions  Businesses with strong reoccurring revenue  An employer looking for “golden handcuffs”

For the education of producers/brokers only. Not for use with the public.27 Funding the Benefit ….  Promised benefits create liabilities  Life insurance is an attractive funding vehicle because:  Makes it possible for an employer to create a large pool of money with relatively small contributions  Welfare benefit fund avoids income tax (that reduce plan contributions) through the combination of tax-deferred internal cash value build up, tax-free access and tax-free proceeds*  Avoids UBIT problems * Withdrawals and loans reduce policy cash values and death benefit, may affect any policy guarantees against lapse, and may have tax consequences.

For the education of producers/brokers only. Not for use with the public.28 Funding the Benefit Using Life Insurance  Can use individual or survivorship life insurance policies - typically universal life policies are used  Where employee turnover is a problem, can fund with a combination of term life insurance and other investments  Welfare benefit trust is the owner and beneficiary  Cash value of policies is accessed to fund post retirement medical and other selected benefits*  Policies can be portable if permitted under terms of the plan * Withdrawals and loans reduce policy cash values and death benefit, may affect any policy guarantees against lapse, and may have tax consequences.

For the education of producers/brokers only. Not for use with the public.29 What Happens if the Plan is Terminated?  Accrued benefits are “frozen” in the plan  Any remaining assets may remain in the plan for future benefits  If assets are distributed, they may not revert to the employer, but must be distributed to all the participants in a non- discriminatory manner following IRS guidelines

For the education of producers/brokers only. Not for use with the public.30 Administrative Needs …  Contribution Calculations  Employee eligibility  Review of emerging liabilities  Communication with employees  Disbursement tracking  Reporting Requirements: IRS, ERISA, etc. A specialized independent third party administrator (TPA) must be use

For the education of producers/brokers only. Not for use with the public.31 Prudential’s Tools …  Producer Marketing Guide  CE Approved Producer Seminar  Market Teaser  Producer Sales Idea  Customer Brochure  Answers to Frequently Asked Questions

For the education of producers/brokers only. Not for use with the public.32