Incidental Benefit on Life Insurance and Rollover

[rocknrolls2]

Ms. XEC receives $1,000 per year in consulting fees and has an IRA with $3 million in assets. In 2002, Ms. XEC establishes Plan M, a profit sharing plan. Ms. XEC then rolls over $2 million from the IRA into Plan M and makes a contribution of $180 to Plan M. She then wants to purchase life insurance on her life.

Under the incidental benefit rule applicable to life insurance under a qualifeid plan, is Ms. XEC able to pay premiums of (a) $500,000 + or (B) $45?

[Belgarath]

This probably depends upon who you ask, and certainly also on the terms of the plan document. But in my humble opinion, the law as it now stands would permit the entire 2 million to be used towards the life insurance premiums.

The incidental limits apply to employer contributions. They do not apply to voluntary employee contributions. This rollover obviously would not be considered an employer contribution.

Effectively, until there is further guidance, there is now a mechanism for allowing the purchase of life insurance with IRA assets, as long as you have a plan which you can roll the IRA assets into and which allows the purchase of life insurance. Since Congress and the IRS have steadfastly refused to allow IRA assets to be used to purchase life insurance (rightly in my opinion, but I'll keep further philosophical opinions to myself) I would think that some sort of technical correction and/or guidance would shut the door on this. And in the situation that you describe, there's a real possibility that the IRS could disqualify the whole arrangement on the grounds that contributions were never meant to be "substantial and recurring." In addition, the IRS has toyed in the past with declaring that while the insurance can be purchased as described, that it would be considered a taxable distribution. They've never pursued this, but this loophole may bring it to the forefront again. I'd want to get advice of some good tax/legal counsel before I'd ever proceed.

[Alonzo]

Query: Where are you getting the idea that you need worry only about employer contributions in determining whether life insurance is incidental or not? The old revenue rulings governing qualified profit sharing plans seem to apply the 25%/ 50% limits to what is held in a participant's account, and do not exclude rollovers or after-tax contribution accounts from the application of the limit.

[Belgarath]

Alonzo - yes, you are correct, and I didn't really mean to imply that it was only employer contributions that counted. What I meant to do was differentiate between employer contributions and voluntary employee contributions. Although Rev. Ruling 69-408, which specifically exempted voluntary employee contributions from the incidental limits tests, was concerning after-tax contributions, I would argue that rollover contributions from an IRA would receive the same treatment.

As I said, I'd consult competent counsel before proceeding on this!