Life insurance in terminating profit sharing plan

[Guest Clain]

I have come across a situation where a participant in a terminating PS plan has a Universal Life policy. It is the sole remaining asset in the plan. The participant wants the policy to remain in force (due to insurability issues) and the policy has a substantial cash value built up. I know the policy can't be rolled over to an IRA, but is there a way to transfer the policy out of the plan to the participant without incurring a tax obligation? If this isn't possible can the plan remain in effect indefinitely with the policy as the only asset?

[pmacduff]

In the "old" days, you could accomplish this by taking a loan out against the policy for the entire amount of the cash value. That amount is then deposited to the Plan Trust and can be rolled out "tax deferred" to an IRA or other Qualified Plan. The policy ownership is then transferred to the participant individually. With a "0" cash value, there is no taxable event. The participant would then have to "repay" the loan to the policy with personal funds in order to replenish the loan. I'm no insurance expert and not even sure if this can still be done this way, but we used to do it all the time to allow a participant to keep the coverage with no taxable event. Others ideas?

[Mary Kay Foss]

I am not an expert in this area but have been to seminars where it is suggested:

1. The policy be distributed and it's taxable at fair market value. Either special policies or special valuation methods are used to keep this value low.

2. The participant can buy the policy from the plan. Apparently there's an exception to the prohibited transaction rules for this.

The seminars have been put on by people selling new insurance with a single premium that has a big drop in value 2-3 years out. There must be some application to an existing policy.

Good luck in finding the best answer.

[mbozek]

There is no requirement that the plan be terminated provided the employer has not been dissolved or gone out of business-- the usual rule for a ps plan is that there must be "substantial and recurring contributions" but a plan could go 5 years without making any contribtions from profits or longer if there is a sufficient business reason for not making contributions, e.g., lack of profits. Or the plan can be merged into another qualified plan.

[Kirk Maldonado]

My recollection is that the only result of the failure to make contributions for an extended period of time is that full vesting of all participants occurs.