Life insurance investment

[Dan]

I got a strange request. The lone participant in a one participant plan asked the following question. Can the plan buy a life insurance policy currently owned by the participant's sister for $X. The insured is the sister's ex-husband. The policy is still in force. I don't know any other details about the policy, premium, cash value etc. Has anyone heard of such a thing? Can it be done? Is there any reason it would be a prohibited transaction?

This one is another step in the "now I've heard everything" direction.

Thanks for any help.

[rcline46]

A plan must be for the exclusive benefit of the participants, who must be emplooyees of the plan sponsor, or their beneficiaries. On the surface it would appear that the beneficiary of the life insurance would be the sister. It is not likely that the sister would be considered a beneficiary of the plan participant.

If you don't follow, the PLAN must be the owner and bene of the policy. Therefore for the sister to receive the policy proceeds, the participant must specifically name her. This violates the rule that the SPOUSE must be tne bene (assuming there is a spouse). Should the plan have J & S rules, then the spouse only needs to be a 50% bene of the total balance including the proceeds. The sister could then be in for up to 50% of the account balance. Will this work?

[jpod]

rcline: Why should we assume that the sister will be the beneficiary? As the owner of the policy, the plan could name itself. Presumably, the sister needs/wants the cash and the participant thinks this is a good investment.

Dan: Is it a term policy? Also, while purchasing from the participant's sister is not a "per se" prohibited transaction with a party in interest, consider whether it might be a fiduciary self-dealing prohibited transaction. Probably not if the transaction can be justified as a good investment for the plan, but you should consider the issue anyway.

[Dan]

Thanks for the responses. I don't believe the sister is going to receive the policy proceeds when payable. The participant is content with the purchase of the policy as an investment. The sister apparently needs cash and this is her biggest asset. But it is not liquid, so I guess they devised this option.

I believe it is a whole life policy. I wonder about whose paying the on-going premiums on such a policy. That is another thing ususual about this proposal.

Since the policy is owned by the sister who is not employed by the plan sponsor and the insured is her ex-husband, I can't see how any self-dealing is evident. But that is a good point to consider.

[jpod]

Any prohibited transaction (and I'm not saying that there necessarily is one) would be attributable to the fact that the policy would be purchased from the sister of the person making the decision to buy the policy.

[ak2ary]

Would the plan or the participant have an insurable interest in the participant's sister's ex-husband?

I dont think so

[jpod]

I am by no means an expert on this, but I believe the "insurable interest" concept comes into play only at the time that policy is issued.

[Bird]

The plan should have a list of permitted investments; I doubt that a policy not on the life of a participant or a key man is listed, but there may be a catch-all provision that would allow it.

Any future premiums should be paid by the plan.

I don't think the purchase of an investment from his sister is a PT but I'd check that more closely.

I'd be curious to know why the sister thinks it is better to sell the policy to the plan, presumably for its cash value or something close to it, as opposed to just surrendering it (and getting the cash value). I don't get the "not liquid" comment (but I can guess that there's a big difference between the accumulation account and the cash surrender value, and if the plan is considering paying the accumulation account it's getting ripped off - the transaction should be for fair market value and FMV is going to be a lot closer to the cash value than to the accumulation account).

FWIW, if the ex dies while the plan holds the policy, the proceeds will go into the plan. Eventually they'll be paid out to the participant as taxable income, so one of the advantages of life insurance, tax-free death benefits, will be lost. At least, I don't think the normal rule that the at-risk portion is tax free applies.

[SteveH]

I have a slightly different take on this. Not saying what other people have siad is incorrect.

1) If the plan decides to purchase the policy from anyone (as long as it is not the plan sponsor so it is not a prohibited transaction) the policy must be purchased for its Fair Market Value. To determine the fair market value you most likely need to have it appraised by in independent third party. You can most likely get this done for about $750.

2) The ownership of the policy must be changed to the plan and the beneficiary is also the plan. You can not have the plan own the policy and then if the ex husband dies the death benefit is paid to the sister. If she sells the policy she is giving up all rights to the policy.

3) Typically the participant would be able to pay "PS-58" costs, now called table 2001 rates each year and include them in their taxable income for that year. Because this is not on the life of the participant, I do not think this is applicable. All death benefit proceeds received by the plan would be distributed as taxable income.

4) Future premiums due would have to be paid by the plan or by the policy itself. As long as the policy has some cash value the policy can pay its own premium.

5) If the sister ever wanted to buy the policy back from the plan, she could only do so if the plan fidicuary deemed that it was a prudent time to sell the policy.

6) There are rules on IOLI (investor owned life insurance). Make sure you are familiar with it. Problems arise when the investor decides that it would really like to collect on the death benefit and the insured is still healthy!!!!

I don't know how much the policy is really worth, but I would think this would be a lot cleaner if the plan participant were to take out a loan from the plan and then buy the policy from her sister outside of the plan. Assumign that the maximum loan allowed would be sufficient to sell it. Are we talking about a situation where the sister needs more than $50,000? Advise the client to keep the policy out of the plan and then she can be real informal about the arrangement. Get the plan involved and you better not screw it up.

If the $50,000 max loan doesn't cover the cost of the FMV of the policy, the sister could buy a partial interest in the policy. The sister would need to become owner and then both sisters could be listed as X%beneficiaries if the ex husband dies. hopefully there is a lot of trust between them. People do stupid stuff when they are desperate for money.