more 412(i)

[Guest jig100]

I've been trying to learn everything about 412(i) plans before I try one and there are a couple things I still can't figure out.

Does anyone have a good article or written explanation of the difference between determining maximum death benefits under the 100 times rule and the alternative rule in Rev. Rul. 74-307 with respect to whole life insurance?

Also I'm contemplating funding a plan with only life insurance (as opposed to a combo with annuities), can anyone provide a techinical response against the following:

1. A 412(i) can be invested only in life insurance

2. The fact that a plan invested only in life insurance contracts will provide that any death benefits under the policy in excess of the inncidental benefits that may be provided under the plan will accrue to the benefit of the plan.

3. The is no fiduciary requirement for an employer to fund a plan in the most efficient manner (i.e. using annuities at a normal cost as compared to the increased costs of life insurance only).

4. A plan that is funded with life insurance only could provide for the sale of the contract (subject to the IRS ruling on sales of policies from a plan) for cash that is used to either purchase annuities or normal plan investments. At that time, if the plan assets do not satisfy the 412(i) requirements, the plan will be subjsect to the normal funding rules unser Section 412.

[Ron Snyder]

I had such an article back in the 80s. Perhaps I could still find it around here some where, but it would not be in electronic format. My suggestion is that you review Tax Facts 1 with respect to the incidental death benefit rule.

"1. A 412(i) can be invested only in life insurance" is incorrect because it should say in "insurance products", not "life insurance".

Normally under a 412(i) plan, the face amount of the policy will be payable to the named beneficiary and will fall within the limits applicable to incidental death benefits. However, there are some promoters taking the approach that it is likely that for a small group a death will actually take place. So they fund the entire retirement benefit including a death benefit in excess of what could be paid out as incidental under the various tests. In such case, they are requiring that any excess death benefits are paid to the plan which will bring the plan back under 412 and out of 412(i), as described under your number 2.

Your third assertion, "The(re) is no fiduciary requirement for an employer to fund a plan in the most efficient manner (i.e. using annuities at a normal cost as compared to the increased costs of life insurance only)" is more difficult to argue either for or against. If there were an argument that purchase of more insurance than necessary was a breach of fiduciary duty, (1) there wouldn't be a Code section 412(i) and (2) the same argument would be made against cash value life insurance instead of term insurance. Instead, the facts of the actual purchase need to be reviewed: How much more expensive is it? What return would alternative investments likely get? How do the guarantees compare? Does the risk vary between the contracts? Etc. But, in general, I would agree with the assertion that there is no fiduciary requirement to fund a plan in the most efficient (whatever that means, since there is a relationship between risk and reward) way possible.

With respect to your fourth assertion, ("A plan that is funded with life insurance only could provide for the sale of the contract (subject to the IRS ruling on sales of policies from a plan) for cash that is used to either purchase annuities or normal plan investments. At that time, if the plan assets do not satisfy the 412(i) requirements, the plan will be subjsect to the normal funding rules unser Section 412.") is generally correct. Certainly the DOL has approved the sale of a life insurance policy for its cash surrender value to a plan participant. And just as surely, if non-insurance assets are put into a 412(i) plan, it is no longer a 412(i) plan.

There is something troubling about your post. You have attempted to construct a syllogism to justify the use of expensive life insurance contracts under a 412(i) plan. There are some threshold questions to address that you have ignored.

1. Does the client need life insurance? If so, how much does he need?

2. Is the 412(i) plan a thinly veiled attempt to create a wealth transfer using pension plan laws?

3. How do the contracts proposed fare under the "springing cash value" rules?

4. Is the proposed sale of the insurance contract an arm's length transaction? How will the policy be valued? (Note that the DOL letter doesn't apply to springing cash value situations.)

5. Will the plan purchase similar policies for all participants?

6. If the plan is overfunded due to the death of a participant, the plan will be subject to excise taxes that will offset any tax benefit of the excess life insurance.

7. Does the amount of death benefit applied for comply with the incidental death benefit rules? Because if not the penalty is disqualification, not an excise tax.