Cash Value Insurance in Terminated Plan

[Guest WHill]

I have a plan that is in the process of terminating. The owner has a cash value life insurance policy for himself in the plan. How do I distribute that to him? He will be taking a direct rollover into his IRA, so can the insurance be rolled over also?

[Guest Kevin Birmingham]

The IRA can't hold the life insurance policy.

If you distribute the policy personally, the cash value is the net distribution after withholding. This means that additional money needs to be taken to pay income tax withholding. For example, suppose the policy value was $100,000. You would distribute the policy, plus you would need an additional $25,000 for the withholding. The total taxable income would be $125,000, 20% of that amount or $25,000 would be withholding, and the client would receive $100,000 in the form of a policy.

To lessen the tax implications, you should be able to strip out most, but not all, of the cash value by taking a policy loan. The proceeds of the policy loan go into the retirement trust, and are part of the IRA distribution. The policy is distributed to the participant, and additional income is used for withholding, but the total dollars that are taxable is usually considerably less. In this case, in addition to the future premiums, the participant would have to repay the loan.

[Guest WHill]

In this plan, the cash value insurance is only worth $28,000. So can the owner purchase the policy from the plan for $28,000, thus making it whole?

[KJohnson]

This would probably work. There is a class prohibited transaction exemption for such a transaciton. I believe it is 92-6