Life Insurance in Qualified Plan

[MBCarey]

If a participant retires and leaves his account balance in the plan and also has a whole life insurance policy. Is it okay to leave the policy in the plan as well and deduct premiums from his account balance? Or should the policy be turned over to him in which case he would be subject to the taxes. Also, would he have to be given a 1099 for the PS 58 costs each year?

[FundeK]

What does the plan document say? Does the plan document state that life insurance can only be held by active participants? Does is state that upon termination the participant must remove the policy from the plan?

[MBCarey]

No, it doesn't say either of these two things.

[FundeK]

Treas. Reg 1.72-16(b)(2) states

If under a plan or trust described in subparagraph (1) of this paragraph, amounts which were allowed as a deduction under section 404, or earnings of the trust, are applied toward the purchase of a life insurance contract described in subparagraph (1) of this paragraph, the cost of the life insurance protection under such contract shall be included in the gross income of the participant for the taxable year or years in which such contributions or earnings are so applied.

I interpret this to mean that as long as the money used to purchase the premiums is tax deferred, you must send a 1099 for those costs.

For estate tax planning purposes, he may not want to maintain the policy in the plan, but I am not an estate planner so I will stop now.

[ccassetty]

You also need to be aware of the incidental rule. Taking premiums from an account balance in which no further contributions are being made could quickly lead to a violation which could jeopardize the whole plan.

If the incidental limit will be a problem, here are a couple of options:

If the retiree has the means, he/she could buy the policy from the plan for its current cash value. This transaction would be non-taxable, the life insurance protection could be continued by the participant outside the plan, and there would be no worries about the incidental limit.

The other option is to have the plan take a loan on the cash value of the policy. This money stays in the plan, then the policy is assigned to the participant who will need to pay premiums on his/her own and could also work on repaying the policy loan. This is not a participant loan and there is no taxable consequences to the employee.