ErnieG

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.

Austin: Loans are not permitted in Fully Insured Plans under IRC 412(e)(3), distributions are allowed subject to the terms and conditions of the Plan.

Yes it will certainly increase the employer's cost in contribution, and administrative fees and soft in-house costs. Their approach is wrong, financial literacy is the answer. There are many ways individuals can save for the future, but do they, not. I am amazed by the simple fact that many individuals fail to establish an emergency fund, let alone saving for retirement. And the number of individuals who do not have a budget. Education and focusing on those less served is the answer. Just my 2 cents (or 1 cent now a days!). Merry Christmas, Happy Holidays, and all the best to all for a safe and healthy New Year.

You may also want to inquire about the independence and type of services performed. Especially on the look out for any managerial functions. A management-type affiliated service group exists when: (i) An organization performs management functions, and (ii) The management organization's principal business is performing management functions on a regular and continuing basis for a recipient organization. There does not need to be any common ownership between the management organization and the organization for which it provides service. Any person related to the organization performing the management function is also to be included in the group that is to be treated as a single employer. [IRC Section 414(m)(5)]

Agreed, a tax exempt employer or government employer is not subject to the excise tax [IRC Section 4972(d)(1)(B)]. Because of this a tax exempt employer could exceed the IRC Section 404(a)(3) deductible limit for Profit Sharing Plans without having the excise tax imposed. However, the applicable dollar limits under IRC Section 415(c) must not be exceeded.

One point on the premiums being paid from the business and not the plan. The business can pay the premiums however the TPA must be aware of such in order to properly perform the incidental benefit test on the entire contributions for the year and past years.