Consequences of Election not to Participate....

[chris]

Plan participant executed an election not to participate going forward effective 1/1/03 (beginning of plan year). Turns out that the Plan has a life insurance policy on the same participant. Since the participant will no longer be participating in the plan, it would seem that the Plan will have to pay the premiums from the participant's account balance going forward given that no contributions will made on the participant's behalf. Does this present any problems going forward?

[MGB]

I thought the general rule was that the policy needs to be terminated or converted to a paid-up policy. Otherwise, you will violate the incidental benefit rules. The safe harbor rules (25% for term, 50% for whole life) are based on a percentage of the amount of contribution. So, immediately, you no longer meet the safe harbor because there are no longer contributions. I assume you ought to be able to show that the current situation would still be incidental (which requires actuarial calculations). However, as time goes on, more and more of the total value of the account becomes a part of the policy and that is going to become a problem.

[chris]

Couldn't contributions from prior years (more than two years) (see Rev Rul 60-83) be used to pay the premiums going forward without regard to the incidental benefit rule? I am assuming the Plan would need to have a provision allowing distributions of contributions accumulated for at least two years in order for the distribution to be inaccordance with the Plan document? Given that a distribution would take place in the form of the premium payment another issue would be the taxability of the premium payment to the participant?? Alternatively, if the Plan provides for a pre-retirement distribution and if the participant satisfies the requirements for the same, maybe the Plan should distribute the policy to the participant?? All questions and no answers.......

[chris]

Backing up a step, clearly the Plan could continue to pay the premiums on the life insurance (whole life) policy in a year where the employer made no contributions to the Plan. The 50% is based on the aggregate contributions under the Plan not just contributions for a particular year. Thus, it would seem mathematically determinable, depending on premium amounts, as to when the aggregate premiums will exceed 50% of the aggregate contributions??

[IRC401]

I am missing something here.

Who is the beneficiary of the policy?

Did the particpant elect to purchase it?

Who makes investment decisions for the account?

If the administrator makes the decision to use assets in the participant's account to pay premiums on the policy, why wouldn't that be a fiduciary investment decision?

Why would the participant elect not to receive emplyer contributions? My instinct is that there is more here than you have disclosed.

[chris]

Nothing undisclosed.... Doctors just tend to do crazy things sometimes.