Life Insurance in a Qualified Plan

[Guest Karen Szy]

I would like to have a discussion about the pros and cons of life insurance in a plan. It seems most TPA's hate it why? What are the administrative hassles if any. Do you charge higher fees for plans with life insurance?

Are there good financial planning reasons to offer life insurance in a plan? What are they? Is there some reference book I can refer to?

[maverick]

Personally I don't feel life ins. "belongs" in retirement plans. I've worked on d.c. plans at 2 banks and 2 CPA firms, and have had admin problems dealing with life ins. in each job. e.g., - Policy year does not equal plan year

- Requirement to complete Schedule A for each policy when preparing the 5500

- Difficulty in getting ins. company / agent to provide policy info necessary to complete schedule A and period-end valuations

- If p.s. 58 costs involved, a separate 1099-R must be issued

- Accounting for life ins. as a separate investment

Ideas if you have a plan that allows life ins.

- Charge an initial set-up fee (especially if you have to liquidate other investments to pay initial and/or annual premiums)

- Charge annual maintenance fee

First post, sorry for long response.

That's my 2 cents. Tom

[pmacduff]

One big problem I always run into with Profit Sharing Plans comes when in years that the employer decides not to make a contribution to the plan, but pays the insurance premiums anyway. They never seem to realize that the premium payment counts as a contribution when made by the employer and not taken out of the plan assets. To compound the problem, many times the owners are the ones with policies, thereby making the plan discriminatory! I've NEVER had a plan with insurance run smoothly. Also - I'm with maverick...at year end it can be like pulling teeth to get any; much less accurate; information from the agents and/or insurance company. I've always been in the small plan market, where these problems are magnified. So that's my two cents to add to maverick's.

[Belgarath]

We have a lot of plans with life insurance in them. I agree that administrative difficulty is magnified. Just depends upon the agent/company selling the insurance. Some good, some not so good, some terrible! But there can be some good reasons to do it. Assuming you have a good CPA/attorney/planner who takes into account the overall picture, including estate planning, then the opportunity to deduct life insurance premiums shouldn't be ignored. And if you do 412(i) plans, and life insurance is needed by the client anyway, then it can help generate some enormous deductions. (But don't ever put life insurance in a plan just for the sake of deductions - the client has to need it!)

[Guest merlin]

I second Belgarath's comments about life insurance in qualified plans. It can be a valuable benefit, and in some cases maybe even of more current value than a retirement benfit.The only problem I have with life insurance is that the person who is assessing the need is usually the one who is trying to sell it in the first place.

[Jon Chambers]

Any realistic assessment of the pros and cons of life insurance inside a plan is likely to conclude that the insurance should be kept out of the plan. It's just too costly. Here's one quick illustration of the problem. Remember that one of the big selling points of insurance is the implicit tax-deferred investment growth on the cash value of the policy. Insurance sales types will tell you this makes up for many of the costs of the policy. But you get tax-deferred growth anyway in a qualified plan.

Insurance agents have told me that they love to sell insurance through a plan because they get a ready source of cash for additional premiums from the annual contribution, so the policy is less likely to lapse. Seems like a weak argument to me, for everyone except the agent who collects a huge commission every year.

[MWeddell]

For the reason pointed out by Jon Chambers above, there's a general question of whether it is a prudent decision for a plan fiduciary to invest or allow participants to invest in life insurance policies. The policies are priced to be competitive if there are bought outside of a qualified plan where the investment component is tax-free, so buying a policy with plan assets constitutes paying for a feature which won't be used because any investment is tax-deferred within a qualified plan.

Per an old ALI-ABA outline I have, the DOL has occasionally challenged the prudence of investing in life insurance policies. However, the cases that are brought usually involved other allegations (typically prohibited transactions), so it is hard to infer what the DOL's general enforcement position is.

[Guest Eric@McHenry]

Jon's comment on expense extends to the nature of the investment as well as operational issues. The "benefit" of purchasing life insurance is available to all participants. I've never seen a rank-and-file participant take distribution of a policy in-kind. When a plan surrenders their policy to pay out the cash surrender value it usually results in a huge hit to "earnings". In a plan with non-key employee turnover of, say, 25% a year (OK, if it's a medical facility, 50% a year...), very few policies will last longer than five years. Well, very few policies have cash value equivalent to premiums paid in before, say, 7 years. As a result, pretty much every employee who owns insurance in the plan and has a distributable event before 7 policy years is under water. It would be tough to consider life insurance to be a "prudent" investment if a fiduciary knows their turnover rate, and has seen the policy illustrations showing the hit during the first 7+/- years...

[Belgarath]

A lot of good points brought up. We primarily handle plans for small employers, and the insurance is at the option of the participant, so typically it is only the keys who elect to purchase it. And they usually keep the policy when plan is terminated. So although I understand the anti-insurance bias that many of you have, I'd just say that you shouldn't automatically discard the idea. There are some situations where it is appropriate and works very well. Many more situations where it isn't!