Another similar Life Insurance in a DB question

[SteveH]

I never really thought that this scenario was any problem, but now I have had someone tell me they don't think the premiums are deductible.

We took over DB plan with 2 partners (owners) and about a dozen employees. Both of the owners have a $250,000 life insurance policy. I have had some confusion on this policy because some years they pay a premium and other years they do not. I have been informed that it is a Universal Life policy and the Trust only pays a premium if the policy requires a premium that year so that it does not lapse.

The Plan does not have any death benefits as an incidental benefit. These policies are basically there because the partners felt that if one of them died the business profitibility would be negatively affected and be burdened with the DB plan. So the death benefit is being used to offset future costs. The way that I understand it, if a partner died the plan would receive $250,000 in cash to help offset future pension costs.

So my quesiton is very similar to Dougsbpc which is still on the front page here. Except in his situation I think the plan is providing the $500,000 as an incidental benefit to the participant. In my scenario the trust is the only beneficiary of any death benefit payment. We have been considering the insurance policy like any other asset. In the years they make a premium payment the cash value is higher then when they do not make a premium payment. There is never very much value in the policy from year to year anyway, never more than a couple thousand dollars. It seems like they pay a premium of about $2,000 and then over the next couple years the policy uses up that $2,000 and the Trust then pays another $2,000.

Now since the insurance is not being used to fund an incidental benefit, I have had a colleague question deducting the premium at all. We haven't given any consideration for the fact that there is an insurance policy in the plan at all. So saying that a portion of the annual contribution is not deductible because every couple years a small portion of the contribution is used to pay an insurance premium isn't making sense to me. Any thoughts?

[JAY21]

My take on it is that with universal life you're usually using an envelope funding approach (vs. split funded where the guaranteed cash value at retirement is subtracted from the projected future cash value of the benefit) which typically would only have the pure "death benefit" portion of the premium added to the funding not the portion of the premium going to build up the cash value of the policy. This add-on death benefit premium is likely to be fairly modest in it's amount. The portion of the premium going to add to the cash value would not typically be added to the contribution and therefore not deducted but the trust assets would include the cash value of the policy which indirectly impacts funding through gains/losses (if immediate gain method) or through future normal cost if a spread-gains method (e.g, Aggregate funding).

This envelope approach differs from using whole life policies where the funding method is usually split funding approach where a specific portion of the benefits are being carved out and funded through the full premium including the portion that includes the cash value accumulation. In this latter case with whole life policies (split-funded plan) I believe the full premium is deducted not just the death benefit portion.

[rcline46]

The policy is an investment of the plan and the plan pays premiums. Like a KEY MAN policy only owned by the trust. There cannot be a separate 'deduction' or inclusion in the Normal Cost of the premium.

[SteveH]

The policy is an investment of the plan and the plan pays premiums. Like a KEY MAN policy only owned by the trust. There cannot be a separate 'deduction' or inclusion in the Normal Cost of the premium.

That is how I understood the policy to work, just like key man insurance. Although I wished I would have remembered that term in my first post.

So I am reading rcline46's post to say that things seem to be ok. Jay21's post is a little confusing to me, but I don't read anything in his post saying that this is wrong either. I think his comments are reflecting somehow that the policy is used to partially fund benefits in the plan where I don't see that happening unless a partner dies or on plan termination if there is a thousand dollars of cash in the policy once it is surrendered.