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Life Insurance Purcahsed with Roth 401k Benefits?


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Scenario: P, age 53, is a participant in a 401k plan with a Roth option and that permits the purchase of life insurance. P is married to S, age 36. P's life insurance agent has proposed that P make the maximum $20,500 in elective deferrals for 2007, and declare them to be Roth. Then, direct benefits in the Roth account to pay for life insurance, under a policy that will be paid up in 12 years (when P reaches age 65, and presumably retires).

The agent explains that whenever P dies, the death benefits will be paid to the plan with no tax, and that when S withdraws those Roth benefits there will be no tax due, not even on the interim investment earnings on the death benefits.

As compared to P purchasing this life insurance on his own, outside of the 401k plan, the recommended approach will shield the post-death investment earnings on the unused death benefits from taxation.

As compared to P purchasing this life insurance inside the 401k plan, but with pre-tax benefits, the recommended approach will shield the death benefits and subsequent investment earnings from taxation when and as withdrawn.

Does anyone know if there's a reason that so leveraging a 401k Roth with life insurance in this way will not work?

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Interesting. I guess there's nothing that says you can't do it, that I know of.

It's always fun to ask the agent what happens if the insured does not die while in the plan. Let's say he's 70 and wants to take all the money from the plan; he can't do a rollover of the insurance so he takes the policy in kind; it's a qualified distribution so no tax. He dies a few years later and it's as if he bought it outside the plan in the first place.

I suppose there's some potential small advantage if he does die while it's in the plan but that would be true of any investment, such as a mutual fund.

Ed Snyder

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What is the advantage of paying the LI proceeds to the plan since the LI will be included in the estate of the employee for fed and state estate tax as the employee possessed the incidents of ownership of the LI. If the benefits are paid to the spouse the proceeds are eligible for an unlimited martial exemption from estate tax. The Q is whether the value of the earnings exempt from income tax will be greater than the amount of the fed and state estate tax due on the proceeds.

Also does the ins co guarantee that the policy be paid up in 12 yrs? Or is this a projection based upon estimated earnings that are not guaranteed?

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"The agent explains that whenever P dies, the death benefits will be paid to the plan with no tax, and that when S withdraws those Roth benefits there will be no tax due, not even on the interim investment earnings on the death benefits."

This is the only potential upside, as well as the potential drainhole (do you hear a giant sucking sound?) which makes the entire house of cards come crashing down.

First, the client is forgoing the current tax deduction. Second, in general, the advantage to a Roth is the potential for income tax free earnings on the investments.

Let me start by saying that I'm not anti-life insurance. I am, however, anti-crapola. And this arrangement doesn't smell like roses.

If the participant lives to retirement, he has made an absolutely terrible choice. He has lost the current tax deduction, to purchase a policy whose INVESTMENT RETURN stinks as compared to other investments available, particularly when the potential upside of successful INCOME TAX FREE investment return on the Roth basis is lost.

Now let's look at the only potential upside as proposed. Participant dies while a participant. (So the gamble is that the participant must die in the next 12 years for this to be successful. If they are that convinced that death is imminent, they should load up on 10 times the insurance available in the plan, with term insurance outside the plan!!!) The life insurance agent, who naturally only has the client's best interests at heart, says that any income earned on the death benefits retained in the plan, as long as it remains in the plan, is not taxable income when withdrawn.

Well, I'm not even so sure about this "advantage." I'm not a tax attorney, but I'm dubious that this is settled tax law or regulation, and that if the client applied for a PLR that this would be the conclusion that the IRS would reach. I'm suspicious that the IRS might conclude that any earnings on the pure life insurance proceeds (the "net amount at risk" - that is, the death benefit minus the cash value at the time of death) would indeed be taxable. I rather doubt that there was Congressional intent in the law to arrive at the same conclusion that the life insurance agent posits. So at the very least, no client should even consider this without an opinion from a reputable tax attorney who is also familiar with qualified plan rules.

That's my two cents worth for the day.

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