ErnieG

Jakyasar: I am not an attorney but are you opining on this from an employment arrangement or for Qualified Plan purposes. The final rule, which takes effect March 11, 2024, only revises the Department’s interpretation under the Fair Labor Standards Act (FLSA). It has no effect on other laws—federal, state, or local—that use different standards for employee classification. For example, the Internal Revenue Code and the National Labor Relations Act have different statutory language and judicial precedent governing the distinction between employees and independent contractors, and those laws are interpreted and enforced by different federal agencies. The FLSA does not preempt any other laws that protect workers, so businesses must comply with all federal, state, and local laws that apply and ensure that they are meeting whichever standard provides workers with the greatest protection. For Qualified Plan purposes the FLSA doe not impact what we have know to be employee versus independent contract under Common Law Rules. The facts that provide evidence of the degree of control and independence fall into three categories: (i) Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? (ii) Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) (iii) Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

For me, the "why not bring them in", aside from the politics of placing the retirement responsibility on the small business owner, is the pricing by TPAs (and rightfully so) of the Owner Only Plan to full pricing. The TPAs I work with generally have a discounted fee for Plans that have only an owner or owners. I fear this may be counter productive by that small business owner terminating or not starting, their Profit Sharing 401(k) Plan due to the increased costs to have this category of employee as a participant in the Plan for deferrals only.

truphao: The life insurance policy is an asset of the Plan, it is as any other asset, owned by the Plan and the Plan is the beneficiary. The employee maintains a beneficiary designation on file, similar to other investments. Upon the death of the insured the death proceeds are passed to the Plan. Upon claim of the Plan's assets by the beneficiary, the life insurance proceeds are split, the net death benefit represented by the face amount of the policy minus it's cash value, is passed to the beneficiary income-tax free. The cash value is added to the other investment and becomes a taxable distribution eligible for transfer/rollover to an IRA or other retirement plan that accepts transfers/rollovers. The 1099 issued reflects the death benefit and the eligible distribution. The calculation of the the net amount at risk and the cash value is performed by the life insurance company as of the date of date showing exactly the face amount and cash value. If there is any basis in the policy (recouped economic benefit cost, known as the PS 59 cost), that is the responsibility of the insured to track.

Considering the sentiment around life insurance in many of these forums which I respect, as a Planner, I am taking another approach. In addition to the 100X's Rule the Theoretical Reserve Rule under 74-307 is also used. We've seen offering this asset, life insurance, which is not correlated to the market, which offers guarantees, a potential for dividends or excess interest, a death benefit that is partially income-tax free at a small cost, and provides an exponential survivor benefit, makes sense in some (stressing some) cases. I believe we all agree we must get paid for our services, how and how much are driven by the client. With life insurance in many cases the totality of the commission received from the carrier offsets other fees that are being charged for various services to Plan and Employer. Bottom line, is it in the best interest of the client and are you fulfilling a fiduciary responsibility.

I agree with Bill, Insurance may be purchased on a participants life as a general trust investment, "key person coverage". This coverage is for the benefit of all participants and not solely for the benefit of any one participant. As a general trust investment the cash value would be included as the other investments on the Form 5500 as Bird points out. Upon the termination of the Plan the life insurance would be allocated per the Plan Document. I am assuming that the life insurance is owned by the Plan and the beneciary is also the Plan and would be curious as to why the owner feels he/she is entitled to the cash value. If the owner has been paying the PS 58 cost it may not be "key person coverage", however, if this is coverage as "key person" there would be no PS 58 cost reported. I would also like to see any minutes or fiduciary reporting that this investment, in the life insurance, was purchased as a general trust investment.

Great forum for this type of dialogue. Thank you.

Agreed, thank you all for your insight and this disucssion.

Luke: My thought is relying on 1.72-16(b)(4) denying basis relates to the non deductibility of insurance premiums under 404(e) for owner-employees. An employer is allowed a deduction under 404(e) and 1.72.16(b)(2) for premiums paid which participants pay the economic cost. Therefore the economic cost creates the basis. However, for an owner-employee the deduction for such cost is not allowed, therefore no tax, but pays on an after-tax basis. The the lack of employer deduction and tax reporting does not cause the after-tax payment to create a basis. Following this one more step, 1016(a)(1)(B) does allow for the creation of basis for life insurance but that basis follows the owner of the policy. In this situation, the owner-employee is not the owner but the plan trust is. Considering no deduction it would be reasonable to assume no basis despite the after tax cost.

Correct and thank you. I'll buy the next round!!!

Using life insurance in a plan, when you have a sole-proprietor or an owner of a pass-through entity, is there a 1099-R required for the economic benefit (PS 58 cost) for such owner? One argument I've heard is a sole proprietor, or an owner of a pass-through entity, is not entitled to a deduction for that portion of the premium representing the economic benefit under IRC Section 404. Accordingly, Treas. Reg. 1.72-16(2) only is applicable if the deduction is allowed under IRC Section 404. Additionally, the instructions for the 1099-R Box 1 states reporting is required if, "...premiums paid by a trustee or custodian for the cost of current life or other insurance protection..." It would appear, if the sole proprietor or owner of a pass-through entity is not taking a deduction for the economic benefit (therefore paying taxes on such amount), the trustee or custodian is not paying that cost, would a 1099-R need to be issued?

Below Ground well said, we can only advise…and document. Whatever comments about plan design, or investments, including life insurance, are usually set up prudently and administered properly. However, something seems to happen from establishment to the time we get involved. Life insurance set up for a need as a survivor benefit and overseen and administered properly is a benefit welcomed by participants and beneficiaries (in my 25 plus years with experience dealing with life insurance in qualified plans I have never had a beneficiary complain about an income tax free death benefit, not have I had a client complain about an exit strategy). Good luck with this case.

I believe if this is not corrected immediately the failure of the Incidental Benefit Rule could disqualify the plan.

Another solution may be see if you can reduce the face amount of the life insurance to maintain the survivor benefit, or place the policy on a reduced paid up status. After that the Plan Document would have language regarding the minimum face amount that must be met in order for the individual to purchase a policy which would limit the ability for this individual to have insurance if they do not receive a high enough contribution to pay the premium.

I would advise him to visit https://www.irs.gov/retirement-plans/rollovers-as-business-start-ups-compliance-project We are trying now to unwind one, the business owner had no idea of the downsides and was sold on the fact that all the money he had in his Plan could be seed money for a startup. Good business for the ERISA Attorney. Good luck.

C.B.: Agreed, there is no reference in 45T that a Plan must cover at least one non HCE. Curious if there will be a correction on this.

Lou S. correct it only applies to each employee who is not a Highly Compensated Employee (HCE) who is eligible to participate in the Plan. It would not apply to Owner-Only Plans.

Coleboy1 as captioned in other posts more information is needed. However, life insurance may not be the only Plan Asset. Life insurance in a Plan generally must be incidental to the primary purpose of providing retirement benefits. To meet this rule, specifically for Defined Contribution Plans there is a percentage of contribution test that is used on an aggregate amount of contributions made on the participant's behalf. This rule generally states that if whole life insurance is being used the premium may not be more than 50% (49.99%) of the contribution, if universal life is being used up to 25% of the contribution may be used towards premiums. There is an exception for funds that have been in the Plan for more than two years and funds that have been transferred in to the Plan. Failure to comply with the incidental benefit rule is a qualification issue and corrective measures should be taken if in fact, there is a violation.

Belgarath: Yes, some insurance carriers have these annuities and some add an endorsement to an existing annuity to comply with IRC Section 401(g) and Treas. Reg. Section 1.401-9. It is a strategy and to avoid the tax on the distribution and the extra expense of setting up an IRA, some advisors use with retirement planning, a "flooring strategy". With this strategy the annuity is covering the fixed expenses of the client and other investments cover discretionary needs and wants. Also, some advisors use a strategy during the accumulation years, similar to rebalancing, but funds are rebalanced to the annuity. The purpose is to provide a pension like benefit at retirement that is not subject to market volatility. You give up any upside potential but you protect any downside loss. Administratively, there are fewer administrators out there than there were in the "old days", agreed.

I misread the original post, it is needed.

In this case the insurance company appears to be correct. The 1099 issued for the distribution, Box 7 for the distribution from a Plan, G for the direct rollover (the nontransferable annuity) and 2a no tax. My experience, insurance company products or not...it depends.

CuseFan: Yes, this option would, or should, be available on a nondiscriminatory basis and subject to the terms of the Plan.

A distribution from a Plan that would not be taxable would be if the annuity contract is "nontransferable". A nontransferable annuity must not have any term that would allow the annuity to be transferred to another with the exception of a transfer to the issuer of the contract. The payments themselves from the annuity would be taxable. Using a nontransferable annuity is similar to transferring the funds directly to an IRA.

Peter: Correct 3.5% on the first 6% of deferral for the match. Matching contribution of: 100% of an employee's contribution up to 1% of compensation and a 50% matching contribution for the employee's contributions above 1% of compensation and up to 6% of compensation; or Nonelective contribution of 3% of compensation to all participants, including those who choose not to contribute to the plan. Employee's salary of $80,000 deferring 10% the match is: 100% on the first 1% of $80,000 = $800 50% on the next 5% of $4,000 = $2,000 Total match $2,800 = 3.50% of $80,000

Agreed, the deemed CODA guidance which would apply to partners in a partnership is a facts and circumstance test for employees. This facts and circumstance is based on the participant's capacity to elect a contribution or not year by year. However, a one-time irrevocable election would not be a deemed CODA.

Agree with comments above, with the exception of the basis. If this is a self-employed individual there is no investment in the contract, no basis generated. Additionally, basis follows the contract. There is a PLR supporting a surrendered contract retains its basis for tax purposes however that conflicts with the Treas.Reg. and Rev. Rul.