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Rollover life inusrance death benefit to Roth IRA


Ananda
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If a 401(k) plan owns a term life insurance on the life of a participant, and the participant dies, the death benefit goes to his children as beneficiaries. The children are requesting that the death benefit, which is income tax free, be directly rolled over into a Roth IRA. I see no problem with this but their accountant is saying that an income tax free death benefit can't be rolled over to a Roth IRA.  Does anyone agree with the accountant?.  

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I don't profess to be an expert on this topic, but Notice 2008-30 has some guidance on non-spousal death beneficiary direct rollovers from a qualified plan to a Roth IRA. 

If the accountant is saying that the tax-free nature of the life insurance proceeds does not in itself mean the plan distribution is coming from a designated Roth account, I would tend to agree. In other words, just because the distribution is not subject to tax does not mean it's a Roth-to-Roth rollover. The distribution is still coming from a non-Roth account (albeit with possibly no tax on the distribution). So it's like a direct rollover from a pre-tax qualified plan account to a Roth IRA, just with a $0 taxable amount in the distribution/rollover process.

Possible that I'm off base, but a thought.

 

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Can you explain why, if the plan document permits rollovers to Roth IRA's, a 401(k) plan non-spouse beneficiary can't rollover the 401(k) monies to a Roth IRA? Is your concern that pursuant to the facts at hand, the non-spouse beneficiary is entitled to the deceased participant's 401(k) held insurance death benefit? It seems to me that if rolling over 401(k) plan assets to a Roth IRA is permitted, and I feel it is, why can't there be a rollover of the deceased participant's 401(k) death benefit to the Roth IRA?.

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7 hours ago, Ananda said:

Can you explain why,

Ananda, it would take me a while to run down the citations, but I'm pretty sure that the death benefit in excess of cash value is treated as if it were a direct payment from the life insurance company to the beneficiary, not as a qualified plan investment. So in your case that's 100% of the death proceeds, since term. Therefore, except for any post-death interest or earnings on the proceeds while in the plan, the distribution is not really a distribution from the plan that can be rolled over to any IRA. Again, I'm just throwin' this out there because I think that is what you will find if you research it. Maybe others can confirm or deny, or you can research further and tell us what you find.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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16 hours ago, Ananda said:

It seems to me that if rolling over 401(k) plan assets to a Roth IRA is permitted, and I feel it is, why can't there be a rollover of the deceased participant's 401(k) death benefit to the Roth IRA?.

I guess you are suggesting that this would be a conversion to Roth upon rollover; it's clearly not Roth money to begin with.  The answer is that it is not eligible for rollover at all.  As Luke Bailey notes, the citations might be tough to run down and connect the dots but I don't think there is any doubt about this.

Ed Snyder

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Thank-you for your responses. My response is that the insurance policy held by the plan is a plan asset and the plan sponsor fiduciary must prudently make this  investment. Thus, since the life insurance death benefit is springing and originating from an ERISA plan asset it would seem that an argument could be made that the death benefit could be rolled over to an IRA as a plan asset.  Moreover, there is some support that the death benefit is a plan asset.  For example, there is some case law stating that if an insurance company does not distribute the full death benefit coming from an ERISA plan but rather pays out the death benefit in installments it is self dealing with plan assets. Strangely enough I did not find any IRS rulings, opinions, notices, etc., addressing this issue, nor any case law on this topic.   

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Some (but not all) relevant sources include:

26 C.F.R. § 1.72-16 https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR807fc2326e73cb3/section-1.72-16

including its (b)(1)(ii): “The proceeds of a contract described in subdivision (ii) of this subparagraph will be considered payable indirectly to a participant or beneficiary of such participant where they are payable to the trustee but under the terms of the plan the trustee is required to pay over all of such proceeds to the beneficiary.”

and its (c)(2)(ii): “The portion of the proceeds paid upon the death of the insured employee which is equal to the cash value immediately before death is not excludable from gross income under section 101(a).  The remaining portion, if any, of the proceeds paid to the beneficiary by reason of the death of the insured employee—that is, the amount in excess of the cash value—constitutes current insurance protection and is excludable under section 101(a).”

IRC § 402(c) http://uscode.house.gov/view.xhtml?req=(title:26%20section:402%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section402)&f=treesort&edition=prelim&num=0&jumpTo=true

26 C.F.R. § 1.402(c)-2 https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/section-1.402(c)-2

including its Q&A-3(b)(3): “An eligible rollover distribution does not include . . .: [t]he portion of any distribution that is not includible in gross income[.]”

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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3 hours ago, Ananda said:

Thank-you for your responses. My response is that the insurance policy held by the plan is a plan asset and the plan sponsor fiduciary must prudently make this  investment. Thus, since the life insurance death benefit is springing and originating from an ERISA plan asset it would seem that an argument could be made that the death benefit could be rolled over to an IRA as a plan asset.  Moreover, there is some support that the death benefit is a plan asset.  For example, there is some case law stating that if an insurance company does not distribute the full death benefit coming from an ERISA plan but rather pays out the death benefit in installments it is self dealing with plan assets. Strangely enough I did not find any IRS rulings, opinions, notices, etc., addressing this issue, nor any case law on this topic.   

There's not really a question of it being a plan asset; it's about how it is treated.  Peter gave you the answer in the first part of his response, specifically "The remaining portion, if any, of the proceeds paid to the beneficiary by reason of the death of the insured employee—that is, the amount in excess of the cash value—constitutes current insurance protection and is excludable under section 101(a).” 

That means it is ineligible for rollover and that's the key.  I give you a little credit for stubborness but you are flat-out wrong.

Ed Snyder

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Thank-you Peter. I appreciate you sharing the citations with the group. Its interesting to note that while the 402 regulations excludes non-taxabe income from the definition of an "eligible rollover" IRC Section 402 does not. Also, Roth IRA's are treated differently given that they accept after tax rollover monies. Its interesting to note that this morning I presented this question to a group of ERISA lawyers that I  net work with and one of them stated that he is aware of an unpublished decision by a district court in the 5th Circuit that concluded that death proceeds from a policy held by a sub-trust within a qualified plan paid to  a non-spouse beneficiary was an eligible rollover to a Roth IRA. He didn't know the specific facts and whether this was an actual holding or dicta, but if I can get my hands on this opinion I'll share it with the group. Thanks again

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Just to supplement my earlier response, another lawyer that is part of our ERISA lawyer discussion group emailed me that he has taken the position that a qualified plan death benefit can be rolled over to a Roth IRA. He based his view on IRS Notice 2008-30 which addressed qualified plan monies  being able to be rolled over to Roth IRA's. More specifically, 2008-30 generally states that qualified plan to Roth rollovers must be "eligible rollovers" as defined under IRC 402(c)(4) and 402(c)(4) does not exclude after tax monies such as life insurance proceeds. Nonetheless, the biggest hurdle to overcome is that the IRS Notice and other sections refer to the participants account balance as being eligible for rollover if it meets the 402(c)(4) requirements. I can hear the argument that a death benefit is not part of the participant's account balance or accrued benefit. Yet, if the insurance company uses the plan as a conduit to pay the beneficiary, as they do in my set of facts, a reasonable argument can be made that this is coming from the participant's account balance and nonetheless, arguing that death proceeds springing from an ERISA plan are plan assets also helps. Nonetheless, we both recognize the risk of challenge by the IRS but we and the other attorneys in our group are not aware of the IRS ever challenging this although they are aware of this practice. 

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On 10/29/2021 at 3:37 PM, Ananda said:

Its interesting to note that while the 402 regulations excludes non-taxabe income from the definition of an "eligible rollover" IRC Section 402 does not.

So your argument is based on the premise that something is in the regs but not in the code, and therefore it doesn't apply.  Just want that to be clear for everyone.

Ed Snyder

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My argument is not premised solely on the fact that a prohibition is in the Code but not the regs. Rather, I and other ERISA lawyers have put forth multiple arguments supporting our position which only applies to nontaxable amounts rolled over or converted to a Roth IRA (e.g., see IRS Notice 2008-30). These arguments would not work for a regular IRA rollover. I do appreciate the views expressed by others and do acknowledge that there is some risk involved in our position but my view and the view of other ERISA lawyers I network with is that if challenged by the IRS "its more likely than not" that our view would prevail in court.

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