Beneficiary on a Life Policy

[Guest MrT]

In a PS/401k Plan the policy is owned by the plan, but who should be named as the Beneficiary in the policy? It would appear to me that the plan should be named as the beneficiary and then the trustee would pay out the benefit in accordance with the Beneficiary Designation form for the plan. If it is not done this way is the Life Insurance Company responsible or capable of preparing the 1099R forms correctly? Is there a higher risk that the plan beneficiary and the policy beneficiary will not match?

[Bird]

You're right, it should be the plan.

[mschwechter]

Hopefully, this is a directed account type plan, otherwise the death benefit would be considered and increase in the Plan's assets, and be allocable to all participants

[mbozek]

The participant can a designate the beneficiary of the LI proceeds the same as any other assets held under the plan since the LI policy is part of the participants account balance. There is no requirement that the plan as owner be named as bene. Naming the plan as the bene creates a question of whether the payment of the proceeds from the plan to the bene would be exempt from income taxation as death benefits from LI because the LI proceeds were paid to the plan and the bene receives a taxable distribution from the plan. Also payment from the Ins co will be quicker than payment from the plan because the bene only needs to provide the death certificate to be paid.

[Bird]

It does not have to be a directed account type plan for the insurance to be properly purchased and paid for the benefit of a single participant (not allocated among all). If the plan permits the purchase of insurance, it will surely have language in it that says the proceeds go into the purchasing participant's account.

I repeat that the plan should be the owner as well as beneficiary. I find the concept of different beneficiary designations for different plan assets bizarre. Not naming the plan as beneficiary creates a question as to who is the proper beneficiary if the plan and policy beneficiaries are different.

[mbozek]

LI in pension plans is commonly used as an estate planning device because the proceeds are income tax free when paid to the bene under the policy, e.g, a trust, unlike cash benefits that will be taxed if paid to a non spouse. The beneficary designation can be different from other benefits paid under the plan because the policy provides for a separate beneficary designated by the participant, see RR 79-202, and there will be no conflict as long the bene designation for the rest of the participant's account notes that there is a separate beneficiary for the LI proceeds. It is not unusual for a plan to designate two separate sets of beneficaries, e.g., MP plan can provide that 50% of account balance will be paid to spouse unless right is waived and permit participant to designate bene of remaining 50% w/out spousal consent.

[Bird]

I agree that a participant can name multiple beneficiaries, but it should be done through the plan's beneficiary designation, not the policy designation.

[Bird]

Just to clarify, I am not saying the plan "must" be bene of a policy, just that it "should" be for a lot of reasons.

LI in pension plans is commonly used as an estate planning device because the proceeds are income tax free when paid to the bene under the policy, e.g, a trust, unlike cash benefits that will be taxed if paid to a non spouse.

I don't know what this is getting at. If estate planning includes reducing estate taxes, then a plan is generally not the place to hold insurance since it is treated as owned by the participant and included in the estate. (Unless you buy into the sub-trust idea.) I don't understand the rest of it at all...life insurance proceeds are generally INCOME tax free, wthether owned by a plan or not (actually, inside a plan they are slowly converted to taxable proceeds since it's only the at-risk portion that is tax-free) and then it looks like you're comparing that to benefits that are subject ot ESTATE taxation if paid to a non-spouse (?)

[mbozek]

The estate tax only applies to transfer of assets over 1.5M to a non spouse which will increase to 2M on 1/1/06.(Less than 2% of all taxpayers are subject to the estate tax.) My illustration was intended to demonstrate that there are legitimate estate planning reasons to have LI in a retirement plan and that the IRS permits a separate bene designation for the LI proceeds. Its not a question of ownership of the LI, it is a question of how the proceeds can be transferred out of an employee's estate to avoid future estate tax.

[Kirk Maldonado]

My recollection, from working on this issue about 15 years ago, that they only way that you get the estate tax advantages was to use a "sub-trust," and even then it wasn't 100% clear that it worked. I've not worked on this issue since then, so my knowledge could be out of date.

I think that the estate tax advantages would be logically inconsistent with the position of the IRS on the income taxation of insurance policies held by qualified plans. (There is an ancient GCM discussing this point in great detail.) But my knowledge on this point is even more dated, it is more than 20 years old.

[jquazza]

-First, both practices are acceptable as the IRS addresses both in section 72(m)(3) and Treas. Reg. 1.72-16.

-Second, unless the PS-58 costs were not properly reported, the death benefits tax exemption of IRC 101(a) apply in either case.

So, the only thing you have to consider, IMHO, are administrative issues.

-When the Trust is not the beneficiary:

-Insurance Company does the tax reporting to the beneficiary. Usually, death benefits are not taxable to the beneficiary under IRC 101(a), however, for those policies that have accumulated reserves/cash values (such as variable life,) the insurance company may not have all the information needed to calculate the proper taxable amount. Most insurance companies will treat the PS58 costs (see PS58 discussion below) as basis in the contract but will not pay attention to other basis (such as premiums paid with after-tax contributions) since they have no way of knowing what source funded the contract resulting in improper tax reporting (usually causing the beneficiary to overpay his/her taxes.) It is only your issue indirectly, since it doesn’t affect your reporting, but affects the beneficiary taxes.

-Payments may not conform to plan provisions (e.g. QPSA benefit payments won’t be made in the form of an annuity; vesting provisions are bypassed, if contract was purchased with employer contributions from a source not 100% vested, the non-vested portion of the death benefits and cash value belongs in the plan’s forfeiture account.)

-You have to look at who controls the beneficiary designation. If the participant has that control, the beneficiary designation may not be in accordance with the plan document. Also, beneficiary changes can cause problems. A participant may change his/her beneficiary in the plan and forgets to change the beneficiary on the contract, or the participant remarries and doesn’t put his/her new spouse as the beneficiary on the insurance contract, the ex-spouse is the named beneficiary of the policy, the new wife is the beneficiary of the plan etc… these cases usually end up being interpleaded by a court at huge cost.

-When the Trust is not the beneficiary:

-Participants’ beneficiaries keep portability of qualified funds (not sure about this one.)

-Trustee has to calculate the basis for proper reporting on 1099-R (also has to determine which portion of the insurance payment related to death benefit and is exempt from taxation.) It might be a very strenuous task, especially for take-over plans.

-Trustee needs to complete all the claim forms which can be delayed and expose the trustee to liability for potential loss of earnings.

[mbozek]

Kirk: I agree that there is no way to avoid having the LI proceeds paid from a qualified plan included in the gross estate because of the non alienation requirement (other than by paying the proceeds to the spouse). However estate taxation of LI proceeds has less impact today than 15 years ago because of the 1.5M exemption for non spousal transfers (2M in 2006). The future estate tax I referred to was meant to apply to estate taxation of the LI in the estates of the heirs of the participant, not the plan participant's estate (assuming that the estate tax will never be completely repealed). 1.5M of LI paid to a trust for the benefit of a participants family will not be be subject to income or estate tax. The income from the trust can be paid to future generations without incurring estate tax.