In-kind contribution to DB plan

[AndyH]

Question I've never been asked before: Can a sponsor of a small DB plan make, as part of the required contribution, a contribution to the plan of corporate owned life insurance, presumably taking a deduction for, and credit for, the cash value of such policy?

Presumably the company's owner is the insured.

Is there anything preventing this from being viable?

What are the issues related to the deductibility?

Clearly there are issues such as PS 58 costs, tax issues upon death or distribution, need to provide equivalent BRF's to other participants, need to satisy incidental benefit rules. What else?

I'm not advocating this; just trying to answer a series of questions. Thanks for any comments.

[David MacLennan]

One issue I can think of:

Generally, you must contribute cash to a pension plan. Specifically, you must contribute cash to satisfy the minimum required contribution under 412. If you have a spread between the 412 and 404 contributions, you can contribute non-cash to the extent of the difference. Because most small plans don't have much of a spread between the 404 and 412 ctbs, non-cash contributions are often not possible. Of course, you can choose a funding method that helps to create a spread between the 412 and 404 ctbs.

[AndyH]

David, thank you for the feedback. I haven't yet found anything in print supporting this, though I'm sure I will. Do you by chance know a cite?

I've found cites related to it possibly being a prohibited transaction, but not anything yet on point about funding, though the two may be related.

[jpod]

It would seem to be a prohibited transaction. There is a class exemption (92-5) that covers transfers of a policy on the life of a plan participant if the transfer is BY THE PARTICIPANT, but you said this was corporate-owned insurance.

[David MacLennan]

I recall from reading somewhere the IRS has always maintained that non-cash contributions to a pension plan in satisfaction of a minimum funding requirement are a prohibited transaction, because it constitutes a sale or exchange. The practice was quite common even so, and after the US Supreme Court agreed with the IRS in 1993 (IRS vs Keystone Consolidated), the IRS gave a kind of confess and pay up and all will be forgotten treatment (Ann 95-14). Profit sharing plans, being non-pension plans, can receive non-cash contributions (but the property must not be "encumbered" in any way (e.g., a security interest or rights of use) regardless of the type of plan).

Re the cites, I did a quick check of the Code and couldn't find anything that states pension plan contributions must be in cash - perhaps that is why it went to the Sumpreme Court. I think the IRS argument was based on the Min Fund Req. The pension answer book, in the section on Prohibited Transactions, devotes a question to this issue - this may be enough to satisfy your client. Otherwise, find a copy of the Supreme Court decision or Ann 95-14. There is also a DOL bulletin but I have not read it.

Re my statement that the 412/404 spread allows a opportunity for the non-cash ctb, I think I just made this conclusion myself a long time ago based on the reasoning, but I probably put some thought into it and may have found other opinions that agree. Use at your own risk!

If they really, really want to do it, this may embolden them: I've taken over admin on 4 or 5 pension plans that have innocently reported non-cash contributions on the 5500, and no audit or letter has ever followed from the IRS. Also, a prohibited transaction excise tax is not the worst fate, and, the audit exposure risk is generally low for all plans. I don't think this would be a qualification issue. Also, would IRS scrutiny lead to a Funding Deficiency too? - I don't think so, since it would seem to conflict with the PT reasoning, but I'm not certain.

[Appleby]

An in-kind contribution to a pension plan is a prohibited transaction because the contribution discharges the employer's legal obligation to contribute cash to the plan.

See the authority attached

[AndyH]

bingo. Thanks to all of you for your help.

[AndyH]

p.s. jpod, the exemption appears to cover purchase by the plan from either the participant or the plan sponsor.

[Guest merlin]

How do you correct the prohibited transaction? Do you withdraw the dollar amount of the contribution? Or must the property itself be removed? If so, at what value,current or original? Or does the withdrawal/removal of a plan asset violate the exclusive benefit rule? What is the "amount involved" for purposes of the excise tax? Does the original transaction satisfy the minimum funding standard account even though it's a PT? If so and the correction is made more than 8-1/2 months after the end of the plan,is there now a funding deficiency?