412i plan compliance

[Gary]

IRS guidance was provided in early 2004. This guidance gave specific details regarding deductions and the valuation of life insurance policies as they pertained to 412i plans.

I began working with these plans during 2004 as well.

My question pertains to pre 2004 412i plan administration.

I have read articles regarding pre 2004 plan administration that presented a technique of handling the incidental death benefit requirement with large amounts of life insurance.

According to the articles, plans were administered so that if a death occurred with life insurance well in excess of the incidental death benefit limit, the plan would pay the beneficiary the incidental death benefit and revert the excess coverage as a windfall to the plan.

The argument made was that the incidental death benefit was not violated, since the benefit paid was not in excess of such limit.

My question is:

What is the general opinion of this approach pre 2004? How common was it?

Thanks.

[Belgarath]

Hard to tell what a general opinion was. In my circle of TPA contacts, it was universally considered pure, unadulterated garbage. I have never knowingly spoken to anyone who thought that it was ok. I would say that it wasn't all that common - mostly limited to a relatively few misguided promoters.

That's is a most unscientific opinion - based upon my personal experiences only.

[SoCalActuary]

The consequence of this design was that the plan was "gambling with plan assets" in that it was spending plan funds to purchase insurance that was unrelated to the purpose of the plan. If the participant were to die, then the plan would have surplus funds available to provide for the benefits of others.

My old schooling on insurance issues was that the policies should not have been underwritten in the first place, because there was no insurable interest in the excessive face amount.

The IRS position is two-fold, as I understand it. First, there is the diversion of plan assets issue with its attendant violation of fiduciary responsibility.

Second, the cost of the excessive insurance could not be related to any reasonable cost method, so the premiums could not be deducted