ErnieG

Bird: Compliance with the incidental benefit rule is a qualification issue. It should not be an issue if properly corrected for that year.

Bird: I could be misreading the original concern, "...but the issue is that the premiums are actually in excess of the allowed contribution..." If premiums are in excess having the premiums paid from the current investment account would still have the issue of excess premium payment. The incidental rule, as you know, are aggregated, not year by year.

It seems there is an "incidental benefit" violation if the premiums are exceeding the incidental benefit limit. This could potentially disqualify the Plan if not corrected. I would look to correct under SCP depending on the specifics or the IRS' new pilot correction program by having an ERISA attorney handle the details. We have caught these failures proactively and remedied by reducing the premium thus reducing face amounts, distributions or purchases of the policies, or surrender.

Belgarath 100% correct on the non-deductibility of the economic cost (one year term rate) the commission issue is overstated. Professional advisors (financial planners, insurance professionals, and those on this forum, act in the best interest of their client. While reality does tell us there are a few, the minority in all professions (stressing all professions) there are those that are in it for greed. Keep in mind commissions first of all are one method of paying for services, and the second, commissions and other costs associated with life insurance have been disclosed (PTE 84-24) to plan fiduciaries prior to the enactment of the fee disclosure rules that we currently have. It has been my experience the circumstances that lead to a discussion of insurance in a plan are those times when an insurance need is uncovered (along with other protection planning topics), it is a permanent need, and the individual does not have the discretionary cash flow to make the purchase with after-tax dollars. The non-deductibility (and associated tax) is a small cost to pay for the exponential benefit of the tax free net amount at risk (face amount of the life insurance minus the cash value) to the survivors. It has also been my experience, especially working with business owners, their Profit Sharing 401(k) Plan is the last resource they will use for retirement income. We could start another forum just on this topic alone. Good stuff.

I believe that position was a remark from an IRS representative at an ASPA conference (don't quote me but I believe it was the 2000 ASPA Annual Conference at the Grand Hyatt in DC). The remark was not an official position of the Service and is not supported by current rules. The issue of seasoned money constituting a distribution and the entire premium taxable is not supported due to the fact that no distribution has occurred. The funds, although currently accessible, are not removed, distributed, from the plan trust, simply reallocated to a pre-retirement survivor benefit, life insurance. Taxation does not occur until funds have actually been distributed from the plan trust. [IRC 402(a)] Totally agree with the limit of 49.99%, best practice is 35% to 40%, leaving room for the cumulative test. An important note in design when dealing with a Profit Sharing Plan is the fact that Profit Sharing contributions are discretionary while insurance premiums are not (in most cases). Also agree with the taxation of the economic benefit, also known as the PS58 cost, which is taxable but it does create basis which is recouped upon distribution. And yes, subject to Benefits, Rights and Features.

Jakyasar this is allowed and used when appropriated and prudent. Section 1.401-1(b)(1)(i) of the Income Tax Regulations states that a qualified pension plan may provide for the payment of incidental death benefits through insurance or otherwise. Section 1.401-1(b)(1)(ii) of the regulations states that a qualified profit-sharing plan may provide that amounts allocated to the account of a participant may be used to provide incidental life insurance for the participant. Also, refer to Rev. Rul. 60-83. Seasoned contributions or aged money is an exception to the incidental benefit limitation. The incidental life insurance benefit limits do not apply if life insurance premiums are paid with “seasoned contributions”. Rev. Rul. 71-295, 1971-2 C.B. 184, and Rev. Rul. 60-83, 1960-1 C.B. 157. This applies to profit sharing contributions only and they must have accumulated in the trust for at least two years. .

RaiCMC just out of curiosity, from a tax perspective, and future retirement income, why would the owner want to reduce his/her account without an tax benefit, as opposed to writing a business check and taking a reasonable business expense tax deduction?

Dave: Ditto on what everyone is mentioning. I've been participating for years, it is amazing the knowledge not only on day to day matters but on issues that are rarely thought of but occur. This is a go to place for brainstorming and knowledge. Thank you.

Basis follows the contract. A beneficiary may recoup basis or it may be recovered as Belgarath stated upon policy distrituion or policy sale. Refer to Treas. Reg. Section 1-72-16(b)(4), "The amount includible in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of paragraph (a)(3) of § 1.72-2) providing the life insurance protection. However, if under the rules of this paragraph an owner-employee is required to include any amounts in his gross income, such amounts shall not in any case be treated as part of his investment in the contract."

The cite EBspecialist may be referring to is the Supreme Court defined term “employee benefit plan” based on the Fort Halifax Packing Co. v. Coyne case in 1987. Since that opinion the Second Circuit developed three nonexclusive factors to assist in determining if the employer’s undertaking involves the similar type of ongoing administration that is inherent in a plan, fund, or program. Although this case related to severance benefits, the three factors are: (1) whether the undertaking or obligation requires managerial discretion, (2) whether a reasonable employee would perceive an ongoing commitment by the employer to provide such benefits, and (3) whether the employer is required to analyze the circumstances of each employee’s termination separately. It would seem reasonable to conclude that if this new program to make lifetime payments to some former employees is a one-time arrangement where there is no ongoing administration (the benefit is funded with a single premium lifetime annuity) then it would not rise to the level of being an “employee benefit plan”. Certainly an ERISA attorney should opine on this for certainty.

Agreed that 280E restricts those companies (cannabis) from deducting associated ordinary business expenses from gross income. There is a school of thought that the Profit Sharing 401(k) Plan or Pension Plan deduction may be allowed under 263A for cost of goods sold. The resulting deduction from gross income would lower the income tax similar to the reasonable expense deduction under 162. There is also some authority for this under Treas. Reg. 1.263A-1(e)(3)(ii)(C) and an IRS Chief Counsel Advisory 201504011. Would like to know other thoughts and positions on this.

My understanding of the FMV, is to be used when the participant takes a distribution from the Plan. I’ll cite Treas. Reg. §1.402(a)-1(a)(1)(iii), “…Except as provided in paragraph (b) of this section, a distribution of property by a trust described in section 401(a) and exempt under section 501(a) shall be taken into account by the distributee at its fair market value.” Also, the Revenue Procedure 2005-25 which provides guidance on determining FMV upon a distribution along with IRC §402(a) referring to “any amount actually distributed” The position, in this author’s opinion, is the valuation of Cash Value for Form 5500 Schedule A purposes is proper and FMV is proper for valuation upon an actual distribution from a Plan.

Mike: The Fair Market Value is used when the annuity contract or life insurance contract is distributed from the Plan. It is the FMV that is used for tax purposes to the individual.

It would be the Cash Value without regard to the Surrender Value. The rational is in a Defined Benefit Plan the assets are being used to provide monthly income, therefore the annuity is assumed to be annuitized. When annuitizing an annuity, the surrender charge is not applied. The reality may be different. I would be curious to learn of a different approach.

We frequently use life insurance in both Profit Sharing and Defined Benefit Plans (when there is a need for survivor benefits). However, I have also frequently encountered the scenario you are outlining. While the strategy fits all the legal requirements if you are abiding by the PTE and the Rev. Proc. it generally lacks economic sense. First, I am assuming there is a valid business entity, second there will be “recurring and substantial” contributions to the plan; third and last, why? The premium is before tax, but the FLP will have to purchase the policy at its FMV as shERPA stated or be distributed with tax due at the FMV. With high cash value policies, the cash value, more than likely, will equal the FMV. Where is the leverage? Assume in 4 years $20 million has been paid in premiums $2.5 x 2 x 4) and there is $19 million in cash value (my experience has been with some carriers’ high cash value contracts the cash value is generally 95% of the premiums paid. Some questions: Is the exit strategy for the policies documented? Does the FLP have the cash to purchase the policies to avoid the tax? Can the FLP pay the tax? If the participants die within the 4 years while the policies are in the plan the beneficiaries will only receive a portion of the death benefit income tax free (the face amount minus the cash value) as opposed to the enitre face amount. Are they prepared to pay the economic benefit each year (also known as the PS 58 or Table 2001 rate or the carriers one year term rate if it is available and regularly sold to the public)? Is there additional cost of administration (TPA fees)? Is the client's other professional advisors (tax and/or legal) on board with this strategy? What happens after 4 years to the policies, who is paying the premiums? Would it be more efficient to spread the premium payments out, more than 4 years, and have IRA distributions pay the premiums?

It has been my understanding that contributions to a Profit-Sharing Plan must be “recurring and substantial” over time for a plan to be considered ongoing and remain viable [Treas. Reg. § 1.401-1(b)(2)]. If the contributions cease to be made, I believe a complete “discontinuance of contributions” has occurred in which would trigger Plan termination and complete (100%) vesting of participants’ accounts [Treas. Reg. § 1.411(d)-2(a)(1)]. This contrasted with a “suspension of contributions” under the Plan, which is merely a temporary cessation of contributions by the employer. We have, in these cases where the employer wishes to suspend their Profit-Sharing Plan, established a Money Purchase Plan with 0 contribution. I am curious as to the wording of the amendment and how it would satisfy the “substantial and recurring” element not to be considered a discontinuance of contributions.

Although this, as stated, is an immediate annjuity, I believe the rule would apply regarding taxation from the plan. In order for the transfer to be nontaxable, one condition is that the annuity contract must be "nontransferrable" [IRC Section 1.401-9(b)] I may be incorrect with the immediate annuity distribution but I cannot locate any language that makes a distinction in such Section. Would like to learn otherwise.

Thank you.

I came across a business owner that implemented an "Individual" Profit Sharing 401(k) Plan back in 2011. Accordingly this do it yourself approcach did not include an employee that was hired in 2014 and still employed. Does anyone have a recommendation for an ERISA Attorney in the Fort Worth, TX area that could prepare and file the VCP?

Purplemandinga these Plans, if properly designed and administered remain viable. As mentioned, the IRS has issued guidance on these Plan however, if the Plan was properly established, the account value should not exceed the cash value as the dividend option should have been to reduce future premiums. The fact that this Plan may be out of 412(e)(3) compliance may mean it is not a 412(e)(3) Plan afterall and could be administered as a Tradional Defined Benefit Plan.

Is the owner a self-employed individual? Any portion of the employer contribution used to purchase insurance for a "self-employed" individual is not a deduction under §404(e). The self-employed individual does not get to deduct the economic benefit portion of the premium and therefore creates no basis for that individual. The policy may be purchased at the Fair Market Value (FMV), with no basis applied), and RMDs may begin at 72.

I agree with Bird. Similar to multiple policies in a Defined Benefit Plan on a participant (policies purchased to meet the operational wording in the Plan Document, usually in increments of $10,000), the economic benefit (PS 58 cost) is reported in total from all the policies. Therefore the basis may be recouped in total. I have not reviewed a cite that would dictate othewise. This is unlike the basis rules for life insurnacde outside a Plan where the basis follows the contract.

It is my understanding, referring to IRS Notice 2005-58 and Treas. Reg. Sec. 1.457-11 as the most recent guidance, a Federal Credit Union may establish either plan. However if they are establishing an ineligible plan under 457(f) it must also meet the document and operational compliance with both 457(f) and 409A.

We approach this by separately testing each Plan, we do not combine them. If life insurance is being used in the DB portion it must pass on its own. The downside is less goes to the HCEs, you lose the ability to use the DC Plan's contributions. We'd suggest using life insurance outside the Plan to cover the HCEs on a Non Qualified Deferred Compensation arrangement.

Rev. Rul. 54-51 requires that for the life insurance to be "incidental", the policy must be converted to a retirement income or distributed to the participant no later than the normal retirement date under the plan. Rev. Rul. 57-213 clarified that the life insurance policy may continue beyond the normal retirement age, provided the participant does not elect to retire. I doesn't matter if they are taking in-service distributions or RMDs provided they continue to work.