From which source in a 401(k) can insurance premiums be paid from?

[mming]

Client would like to start up a 401(k) plan for he and his wife (only employees) that also allows PS contributions. They both have account balances from an old SEP-IRA that they would like to rollover into the new plan. Can these rollover amounts be used to pay for insurance premiums in years where they do not make any contributions?

Although every year the premiums cannot exceed 50% of the contributions (they want whole life), would the elective deferrals count as the contribution in addition to the profit sharing?

The document can be drafted to allow for withdrawals pursuant to the IRS 2-year rule. The doc also states that such amounts can be used in addition to the incidental benefit limit to pay premiums. That would seem like an easy way to circumvent the incidental benefit limit by using plan assets to pay for the premiums (at least partly) as opposed to the employer paying the whole amount. Are there any other aspects to this that should be considered?

[QDROphile]

Other aspects that should be considered: Life insurance should not be an asset of a qualified plan.

But you and the insurance salespersons and related hangers-on may disagree.

[david rigby]

How old are the parties?

What is the purpose of of the parties in establishing this (or any) qualified plan?

How much cash can they put into a qualified plan?

Will the ER contribution be maintained for several years or is it temporary?

[mming]

Pax - they are in their early 30s and know the plan should be a long-term commitment. They would like to contribute and defer the max every year and since they can now tack on the deferals to a 25% contribution and they have a modest income, a 401(k) appeals to them. The contributions being discretionary was important also.

For the record, I cringe whenever I hear of a plan possibly becoming infected with insurance, but sometimes people can't be talked out of it. I believe the main reason for the insurance was the premiums can possibly be paid with pre-tax monies (hence my questions re: sources) and since they were going to get insurance and pay premiums with or without this plan, deducting the premiums as contributions would be a plus. How do you usually see 401(k) plans handle premiums?

[david rigby]

In most cases, it is advisable to avoid trying to do everything with one plan. A qualified plan's primary purpose is to accumulate retirement income. (Please no lectures about other "purposes.")

To provide death benefits, the most advantageous vehicle is usually group life insurance. The answer may be different if there is the need (do not confuse "need" with "want") for permanent, rather than term, insurance. Perhaps the parties can accomplish there goal thru group life, rather than try to confuse the qualified plan's purpose.

[Belgarath]

mming - as you can tell, from a TPA point of view, insurance in a plan is about the biggest PIA since chocolate teapots. That having been said, and assuming the employer is going to do it:

1. Assuming the document allows it, you can use the rollover funds to pay premiums.

2. There is another issue which should at least be considered. The IRS (actually Jim Holland, I believe) at one time informally opined that the "withdrawal" under the 2/5 rule to pay life premiums would be considered a taxable withdrawal. They've never done anything to formalize this, and I don't see anyone worrying about it. The prevailing consensus is that as long as the employee is declaring the taxable term costs, the premiums are not otherwise taxable as a distribution. But it should at least be considered by their tax/legal counsel.