LIFE iNSURANCE DEATH BENEFITS AND SPOUSAL ROLLOVER

[Guest Ed Walker]

i have profit sharing plan that includes life insurance benefits. We have reported PS 58 costs every year.

At the participant's death the spouse has elected to rollover the plan benefits to her own rollover IRA account.

I believe the net insurance value, the differance between the death benefit and the cash value, should not (cannot) be rolled over nor is it subject to income tax or withholding.

I know I am looking right by it but, unfortunately I can't find the cite to make me comfortable. Am I correct?

Thanks for your feed back

ED

[Michael Devault]

IRC section 408(a)(3) says that an IRA cannot contain elements of life insurance.

Treas. Reg. section 1.72-16©(4) indicates that the net amount at risk (the death benefit minus the surrender value) is treated as life insurance proceeds under IRC section 101(a) IF the PS58 costs are paid with after-tax contributions or are included in taxable income, as in your case. Section 101(a) excludes the death benefits from income.

Hope this helps you.

Mike

[Guest Harry O]

An eligible rollover distribution does not include any portion of a distribution that is not includible in gross income. Section 402©(2). Since the net amount at risk is not taxable (per the citation in the previous posting), it would not be eligible for rollover.

[mbozek]

The net amount of the LI proceeds are not subject to income taxation when paid to the beneficary and therefor should not be rolled over. Q- is the spouse the beneficary of the LI proceeds or are the proceeds paid to the plan trustee as beneficiary and then distributed to the spouse. If the latter is the answer then LI proceeds are taxable to spouse and can be rolled over to an IRA. The amt of the cash surrender value is reduced by the amt of the PS 58 cost or amt of any employee contributions to the LI.

[Belgarath]

mbozek - can you clarify what you are saying in your question? Although I'm sure you didn't mean to say this, it sounds like you are saying that life insurance proceeds (i.e. net amount at risk) become taxable to the beneficiary if paid to the plan trustee as beneficiary first, and of course this simply isn't true. Are you really just referring to the cash value? Thanks.

[mbozek]

My understanding is that there are some old IRS rulings that held that the income tax exclusion for death proceeds only applies to the party who is designated as the beneficary under the policy. If the plan administrator/trustee is designated as the beneficiary then the exclusion applies only to the plan admin/trustee and the insurance proceeds are considered a taxable distribution when paid to the plan beneficiary. I have discussed this issue with TPAs who usually disregard these precedents and issue a 1099 to the beneficiary showing the proceeds to be excluded from income as ins. proceeds.

[Belgarath]

Mbozek - sorry, but we aren't disregarding anything. If you take a look at 1.72-16, I think you'll agree that the rules are crystal clear on this - if it is payable to the beneficiary of the participant under the terms of the plan, which it is, then the life insurance portion isn't taxable as income. (although it is part of the taxable estate subject to estate tax, absent some sort of subtrust, which is an aggressive and unproven technique)

[mbozek]

I was referring to an old ruling (RR 66-138) which held that if the proceeds are paid directly to the trust as the beneficiary and commingled with other assets of the trust then the participants willl not be deemed to have received any portion of the LI proceeds. In some plans the proceeds of the LI are not allocated to the deceased participant's account and all particpants share in the proceeds on a a non discriminatory basis.