Distribution from a Defined Benefit Plan with insurance

[Guest fresno]

A terminated participant's Present Value of Accrued Benefits is $100,000. The plan contains individual life insurance policies and the participant has elected to receive the life insurance and maintain the policy as part of his distribution. The policy has a current surrender value of $20,000. He has elected to rollover the balance of $80,000 to an IRA.

For 1099R reporting purposes would he receive two 1099R's - the first reflecting the $80,000 rollover (code G) and the second representing the $20,000 current surrender value of the life insurance policy (code 7).

Would there be any tax withholding ($4,000 based on 20% of the $20,000 cash surrender value) or would it not apply, since a life insurance policy cannot be rolled over to an IRA.

[ERISAnut]

Since there is no cash received from the distribution, there will be no 20% withholding. As for the Distribution of the Life Insurance Policy, the participant should receive a 1099-R for the fair market value of the entire policy. Of coarse, a portion of this fair market value would represent Table 2001 Income (P.S. 58 Costs). He would have 60 days to rollover the "taxable" portion of the policy.

As for whether he will receive one 1099-R or two, I don't know. I presume that could be represented on only 1 but have never seen it done that way. Generally, a 1099-R would be produced based on the distribution code in box 7 where all distributions subject to the same code would be on a single 1099-R. The $80,000 rollover would be coded "G" for rollover. This other 1099-R may have a code of 1,2 or 7 depending on the age of the participant. It will also have the P.S 58 Costs box completed.

[himt4]

You might also want to double check that the surrender value is the proper amount to be shown on the 1099-R. You probably need to report the "fair market value" and I though that Rev. Proc. 2005-25 made this more complicated than just using "surrender value" as "fair market value"

...greater of: A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and B) the product of the PERC amount (the amount described in the following sentence based on premiums, earnings, and reasonable charges) and the applicable Average Surrender Factor described in section 3.04 of this revenue procedure.

Hopefully, I am wrong, but I had a similar question when a client was buying his policy from the plan. The purchase price used to be the "surrendr value" but now its this crazy 2005-25 calculation. I imagine its the same logic if client is taking over policy instead of buying.

http://benefitslink.com/boards/index.php?showtopic=30911&hl=

You may need to ask the insurance company to calculate the "fair market value" under 2005-25.

[Guest fresno]

Thank you for your responses. Does anyone have a cite that confirms that the 20% withholding would not apply to the distribution of the life insurance policy to a participant combined with a rollover?

[ERISAnut]

Thank you for your responses. Does anyone have a cite that confirms that the 20% withholding would not apply to the distribution of the life insurance policy to a participant combined with a rollover?

The withholding rules are in Section 3405 of the Internal Revenue Code. Remember, when the policy is distributed and all cash is directly rolled over, there is no cash received from the distribution.

[Guest fresno]

The question that is being raised, is should the distribution of the life insurance contract be treated as a noncash distribution, such as a piece of land, which would require 20% withholding on the value of the land to be paid from the amount eligible for rollover, providing a rollover value of $80,000 - 20% of the 20,000.

31.3405©-1 Q&A#9

thank you

[ERISAnut]

Can you take it to a bank and cash it?

Just poking fun....

Anything other than a check made payable to the participant would not be considered a cash distribution. This includes a Loan offset, Life Insurance Policy, Employer Securities taken in-kind, etc...

It would have to be "cash", not something that cash is used to purchase. Otherwise, there is nothing to withhold from without liquidating. The idea is that if it is liquidated into cash, it would be rolled over, leaving no more cash.

[Guest fresno]

The following is from Taxation of Distributions from Qualified Plans. I have not been able to find an exception for the life insurance policy.

thank you

¶ 21.03[3][c] Distributions of Noncash Property

If all or a portion of an eligible rollover distribution is made in property other than cash, and if the cash in the distribution is not sufficient to satisfy the withholding obligation, the plan administrator or payor either must sell all or a part of the property, or must receive cash from the recipient in an amount sufficient to pay the withholding. 68 However, the maximum amount to be withheld on any designated distribution (including any eligible rollover distribution) must not exceed the sum of the cash and the fair market value of other property (excluding employer securities) received in the distribution. 69 If an eligible rollover distribution consists solely of employer securities, no amount is required to be withheld as income tax. 70

Example 21-6

Participant C has a $50,000 account balance under Plan Q, a qualified profit-sharing plan. C does not elect to exercise his direct rollover option but elects to receive the full $50,000 from the plan. C 's distribution will consist of $5,000 in cash and $45,000 worth of publicly traded securities. Plan Q must withhold $10,000 ($50,000 × 20%). Thus, Plan Q will withhold the full $5,000 in cash. The balance of the $5,000 withholding either must come from the proceeds from the sale of $5,000 worth of the publicly traded securities or from cash provided to the Plan by C.

Example 21-7

Assume the same facts as in Example 21-6, except that the $45,000 worth of securities consists entirely of common stock of the employer sponsoring Plan Q . In that case, Plan Q satisfies the withholding rules by withholding only the $5,000 in available cash. None of the employer securities need to be liquidated to satisfy the 20 percent mandatory withholding requirements.

If net unrealized appreciation, within the meaning of § 402(e)(4) , is included in an eligible rollover distribution, the net unrealized appreciation is not a designated distribution under § 3405(e)(1)(B) to the extent it is reasonable to believe it is not includible in gross income. 71 Thus, to the extent net unrealized appreciation is excludible from gross income under § 402(e)(4), it is not included in the amount of an eligible rollover distribution that is subject to the 20 percent mandatory withholding requirement. 72

If an eligible rollover distribution includes an offset amount for a plan loan that was outstanding at the time of the distribution, the income tax withholding requirements with respect to the loan offset amount are limited in the same manner as in the case of a distribution of employer securities. 73

[Belgarath]

Enut - I'm not so sure. The Q&A-9 that Fresno refers to says that for property OTHER THAN cash, employer securities, or plan offset loan amounts, you go to 35.3405-1, Q&A F-2 and F-3. When you look at these Q&A's, it provides methodology for the withholding.

I'd say the withholding must be done. Foolish as that seems.

[Guest Pensions in Paradise]

I agree that 20% withholding would apply to the distribution of the life insurance policy. See ERISA Outline Book, Chapter 7, Section X, Part B.3 (2005 Edition).

[ERISAnut]

Wow, I stand corrected. The exception to the 20% withholding applies to only "certain" cashless distributions instead of "all" cashless distributions.

Certain in this case would seem to mean anything other than life insurance (though there could be others). I never knew this; but it's good to know.

[Mike Preston]

A terminated participant's Present Value of Accrued Benefits is $100,000. The plan contains individual life insurance policies and the participant has elected to receive the life insurance and maintain the policy as part of his distribution. The policy has a current surrender value of $20,000. He has elected to rollover the balance of $80,000 to an IRA.

If the plan is so inclined, they can assist the participant in escaping the withholding. First, have the Trustee borrow from the policy such that its surrender value is essentially zero. Then have the participant obtain a participant loan from the plan in the same amount, and on the same terms, as the plan arranged with the policy (if possible). When it comes time for a distribution (one day later?) the plan will distribute the $80,000 as a rollover and a life insurance policy with little or no value, along with a participant loan in the amount of $20,000. The participant can then repay the insurance loan, restoring it to the condition it was in before all this took place. The distribution from the plan was not subject to withholding since the participant loan is a qualified offset.

[Belgarath]

Mike - I'm not sure this will generally work so well. A lot of plans won't allow participant loans to terminated participants, particularly if they are just about to receive a distribution.

Why not just strip the policy as you suggest, then roll that money into an IRA - then withdraw it from the IRA? Assuming you put it into something no-load/no surrender charge, this should work fine. And you can elect out of any withholding on the IRA distribution if you so choose.

All this, of course, assuming that CSV and FMV are the same. I haven't taken the time to consider how this would play out if the FMV is higher. Not on a Monday morning...