Taxability of life insurance held as an asset in PSP

[billfgrady]

Employer A and Employer B both sponsor profit sharing plans which permit self-directed investment by plan participants. Employee A, while a participant of Employer A's Plan A, purchased a life insurance policy on his own life, which was held as an asset of Plan A. Vested portions of Employee A's Plan A self-directed account were used to pay the premiums on this whole life policy (all within deductibility limits for PSPs and permitted by Plan A). Employee A terminated employment with Employer, was employed by Employer B and is now a participant in Plan B. Plan B does not permit rollovers of any kind. Plan B does permit the Plan to hold life insurance as a Plan asset (although the Employer discourages this). Employee wants to know whether he may roll the life insurance policy and funds into his Plan B account.

It is clear that the non-life insurance funds held by the Plan may be rolled over into an IRA since Plan B does not permit rollovers. However, the funds attributable to the life insurance policy may not be rolled into the IRA. Employee A is younger than the ERD or NRD for both Plan A and Plan B. The cash surrender value of the life insurance policy is significant (250,000+). The question is, what to do with these funds to avoid a taxable distribution?

My understanding is that, if Employee A pays to Plan A out of his own personal funds (i.e., no Plan A or Plan B funds) the cash surrender value of the life insurance policy prior to rolling the funds into the IRA, there should be no taxable event and Employee A can own the policy outside of the plan. Correct? Any other ways about this?

[ccassetty]

I assume the participant really wants to keep the policy so I believe your solution of having the participant purchase the life insurance from plan A will work and is the best solution, if he can come up with the money. One other alternative is available that will allow the participant to keep some of the life insurance coverage without taxation of the cash value if he can't come up with $250,000 cash. This involves plan A taking a loan for the taxable amount of the cash value (cash value less accumulated PS-58 costs), rolling the the loan proceeds to the IRA then changing the ownership on the insurance policy to the participant. The drawback is that the death benefit provided by the policy is reduced by the outstanding loan amount, which, if not paid back will continue to grow with interest, continually reducing the face amount of the policy.

Carolyn