Life Insurance in DB Plan

[Guest Scott McHenry]

Frozen, small employer plan is $1,000,000 underfunded. Plan is subject to PBGC and substantial owner would bear the reduction in allocation if standard termination.

Owner's intention is to keep Plan open and fund over 3-4 years (250,000 - 300,000 a year).

The plan does not have a death benefit other than PVAB.

Can plan purchase life insurance on owner's life? The intention would be that the life insurance would fully fund the plan if owner dies before plan is fully funded. The intention is for the life insurance to be just an asset of the plan and not used to provide additional death benefits.

Does the 100 times monthly benefit rule apply? Does life insurance have to be offered to the other participants? Any other concerns?

Thanks.

Scott

[mschwechter]

I would think that if the insurance was owned by the Plan, and the Plan was the beneficiary, and the defination of Death Benefit did not change, and especially if the insurance was a 3 or 5 year decreasing term policy, it would be ok, and an investment / expense of the Plan, (PS58 costs would also not apply).

If you are looking at whole life, I would have to say why, since you are trying to cover a short term decreasing liability.

Thus can also be done outside the Plan as a key man policy to cover the contigency.

[david rigby]

Prudent standards would presumably apply to all investments made by the plan.

[JAY21]

Normally I believe life insurance would be a benefits, rights & feature subject to being offered on a non-discriminatory basis under Treas. Reg. 1.401(a)(4). However, since the plan is the beneficiary, with no pass through of proceeds to any particular participant, perhaps these regs wouldn't apply in this situation.

[Guest smhjr]

Aren't you putting the plan in a situation where the contribution for the life insurance is not deductible? You would be making a deposit into the pension trust not for the benefit of any of the participants or their beneficiaries. Although if the owner died and the death benefit went to the trust, the eventual cash would be used to pay benefits to the participants, but if he doesn't die....

I don't think you are going to be limited to 100x because that limit is the incidental limit to be paid to an individual participant, if this death benefit is not going to be paid to any participant then I don't think you have a monthly benefit to limit the amount to.

If you use term insurance and it's not deductible then why bother contributing it to the pension trust? You are going to be unecessarily subjecting yourself to a 10% excise tax.

I would think if this is really his concern then just have the company buy some key man insurance like mschwechter has said and then if the owner were to die the company would have 1,000,000 to contribute to the plan and make up for the shortfall. My cousin is an insurnace agent and so I know there is something called annual renewable term insurance which is pretty darn cheap, although you do have to requalify every year for it. That would allow you to adjust the death benefit each year though to match the shortfall.

[Guest flogger]

The Plan can make an investment in an insurance policy for the very purpose they are seeking--to make the plan whole in the event of the owner's death. The premiums for the insurance would come out of the Plan's trust.

The incidental death benefit rules are irrelevant as the death benefit is the PVAB. It may be that upon the death of the insured, the plan could become substantially overfunded and a reversion problem could exists.

As to the type of insurance they would buy, it does seem logical to use ART (annual renewable term), but it may be OK to use a cash-value type of policy. Any cash values in the policy would be considered assets of the trust.

To prevent discrimination in terms of benefits rights and features, I believe that some action would have to be taken in order to prevent the owner from having the ability to transfer the policy out to himself at some point. I believe this could be done by stipulating, in the Plan document's trust section or in the insurance policy itself, that the policy cannot be transferred out of the Plan.

[Guest smhjr]

But isn't the discussion in Rev. Rul. 2004-20 talking basically about this same thing? It says that:

"Rev. Rul. 55-748 holds that the part of the employer's contribution attributable to the purchase of life insurance benefits, which, when they become payable, are applicable to the reduction of subsequent employer contributions to the plan are not considered as a cost of the pension plan for the purpose of determining the limitations of deductions under §404(a)(1)(A), (B), and © of the Code for the year in which the contributions are paid, and cannot be deducted as such."

It goes on further to say:

"Rev. Rul. 55-748 provides that the employer may deduct in that year, in addition to this current contribution, the contribution made in prior years and not then deductible because they were attributable to that part of the retirement income contracts that would provide life insurance payable to the trustee, to the extent of the difference between his current contribution and his maximum deduction permitted under §404(a)(1)(A), (B), or ©.

I read that to mean that you could put the insurance in the plan, but if it is a plan asset that is only going to pay off in the event of someone's future death then it is not currently deductible and is subject to the excise tax. In fact this rev. rul. basically says that you can put as much insurance as you want in a plan as long as you don't deduct anything over the incidental limits and pay the excise tax. It also talks about using 1 year term rates to determine how much of the cost is not deductible. I figured that was talking about when using a whole life policy in the plan. A portion is a current plan asset and is deductible and a portion is cost attributable to future income and not currently deductible.