distributions of life insurance

[Fred Payne]

Dr. A retired from his practice that his colleague is continuing; thus the Plan survives. Dr A has a life insurance policy as a Plan asset and has received a distribution of all of his account balance but for the life policy. It cannot be rolled over into an IRA, nor does Dr. A desire to take ownership of the policy and pay taxes on this distribution to him. So he's left it in the Plan hoping that his old collegaue does not someday terminate the Plan prior to Dr. A's death and force the distribution to him.

Dr. A has a tree farm but did not want to set up a plan for the tree farm. But could he set up a 0% money purchase plan to accept the distribution of the life insurance policy? The policy has sufficient value such that premium payments are being funded internally by the policy itself.

What is the downside of this approach?

[Guest PAUL DUGAN]

I have a problem with a 0% MP or PS with out contributions. If there are premiums payable the contribution must be at least twice the premium.

We administer a number of plans with insurance, it is our standard practice on Ret., Term. of employment, or plan term to borrow the cash values down to the accumilated PS58 cost. The policy is then transfered to the participant with out any tax due. The participant can then elect to repay the loan, surrender the policy, or make minimum payments needed to cover minimum required payments (normally very small or zero if the policy is older).

[Fred Payne]

Paul:

Thanks for the creative suggestion re: borrowing down to the accumulated PS58 cost and then transferring it out. This is the first plan we've ever had with life insurance in it, so I'm really in the dark on this one. I'll have the agent run an illustration that shows the resulting on-going carrying costs. I interpret your remarks to suggest that the accumulated PS58 cost is basis to the account beneficiary much like a distribution of after-tax contributions. Correct?

Remember, I said this guy was a doctor, and as we all know, doctors always don't chose to do what is the wisest. I need you to clarify your comment re: your disdain for the "0% MP or PS without contributions." By definition, does a 0% MP not ever get a contribution? Is it that you don't like the 0% contribution idea OR just a 0% Plan when the Plan holds a life insurance contract? If there are premiums to pay, I can see where a 0% contribution plan would create problems. But if the policy has sufficient dividends to pay the premium and no contributions to the Plan are needed to pay the premiums, do yo have a problem in that instance with a 0% Plan?

[Guest amfam2]

I researched a case like this earlier this week - would like to share w/you one thing I found in regards to PS-58 costs & basis: Treas Reg. 1.72-16(B)(4).

If the doctor is considered self employed (perhaps as a partner in a partnership), this Reg indicates that he does not have basis in the policy upon surrender.

You may want to look at the reg and see if (or how) it may apply to this situation.

[Kirk Maldonado]

Paul Dugan:

Is your position consistent with that underlying IRS Announcement 88-51 and Notice 89-25, Q&A #10?

[Earl]

isn't there a UBTI issue with life ins loans?

[Guest amfam2]

To Earl:

I am not sure if there is a UBTI issue w/taking loans on insurance policies, but they are a tax trap.

A lot of individuals may incorrectly believe that the loans are tax free. But there are traps when an individual does not repay the loan and/or uses the remaining cash value of the policy to pay premiums...

There is a wonderful article about this technical/tax issue (and written in a simplistic way!) in the magazine Best's Review, November 2000, titled "The Pitfalls of Policy Loans".

They give some great examples on how the strategies described in this email thread may nail a client with a high tax bill if the client isn't careful..... jlg

[Guest Harry O]

Kirk,

How is this inconsistent with Notice 89-25, Q&A 10?

This does not appear to be "springing" cash value life insurance.

[Kirk Maldonado]

The issue is whether you are assigning a proper value to the policy or some artifically low number.

[Guest Harry O]

Kirk,

Assume we have a one participant plan and the only asset is an insurance policy with a CSV or $100. The trustee borrows $90 of the CSV and then distributes to the employee (1) a life insurance policy with a net CSV of $10, and (2) $90 cash. The employee receives a Form 1099R reporting $100 worth of distribution. Where is the problem?

The policies described in Notice 89-25 were different and designed to understate the amount reported on the Form 1099R. The stated CSV was much lower than the reserves established by the insurer. In the example above, my understanding is that the insurance company's reserves are reduced by the amount of the outstanding policy loan. Thus there is no "mismatch" between the net CSV and the insurer's reserves.

I guess I still don't see the problem but perhaps I am missing something . . .