Life Insurance as plan investment; incidental benefit rule violated; h

[Guest Lex]

A company sponsors a 401k and a PS Plan. They allow participants to buy term insurance in the PS. The incidental benefit limit has been exceeded for some participants, even using the 100% rule for PS plan with contributions greater than 2 years old. We are counting the historical PS contributions and the deferrals made to the 401k as employer contributions for this purpose. The employer has not made a PS contribution in several years- that has caused the limit test to be violated for a few participants.

What is the corrective measure to fix this problem for those participants?

[ccassetty]

There is no officially sanctioned fix for this that I am aware of, however, I would suggest that you contact the issuing company and ask for options. Some companies will retroactively reissue policies to lower face amounts and refund premiums in excess of the incidental limits. To do this you will need to determine in which year the policies first exceeded the incidental limit and reissue the policies back to that year. Remember that the incidental limits must be met at all times, not just in total.

Putting term life insurance inside of a qualified retirement plan is not a good option. In the first place, all the premiums are taxable each year, defeating the purpose of putting it inside of a tax shelter. Second, the premiums increase each year, making it likely that all participants, sooner or later, will violate the incidental limits (at least the 25% limit if not the aged money limit).

Just my opinion, but I would get all of the term policies out of the plan once the current incidental limit problems have been fixed.

[mbozek]

CC: Most term policies have premiums which are fixed for 5, 10 or twenty year periods. But Otherwise I agree with your opinion. there is no valid basis to have term ins in a ret plan becuase ther is no inside buildup of cahs value. The rationale that pre tax dollars are used to purchase the ins is defeated by the taxation of the premiums under the PS 58 rates (unless there is a wide disparity beteen the premium paid and the PS 58 taxation).