Help for a newbie

[Guest Biggie]

Hi, I'm a physician in private practice. I've been recommended to start a DBP for myself. I've been advised to purchase universal life insurance through the dbp into some protected account which I can apparently swap out at some point down the road. There are apparently some tax benefits to this method. Can anyone explain this to me further and give some advice for a newbie?

[Guest GMP]

Seek the advice of someone who doesn't work on commission, like a local actuary.

[Effen]

I agree with GMP. Talk to your accountant and attorney. If neither of them understand qualified plans, ask them to recommend someone who does not sell product. You should be able to find an actuary or TPA who can look at your situation and give you some general recommendations. If you need life insurance it can be part of the qualified plan, but it shouldn't be the driving factor. Find someone who isn't trying to sell you something.

[SoCalActuary]

Here's a few thoughts to consider:

1. A DBP will allow you to fund for a lumpsum value of about $2.4 million dollars in your retirement fund at age 62.

2. Life insurance is allowed in the plan, but the cost of insurance is taxable to you, so why have it in the plan?

3. Without the insurance, your salesman will get paid a lot less but you will have more money in your pocket.

4. A deferred annuity contract is a valid form of pension plan investment, so long as you realize that the insurance company will get their profit first, and the sponsor of the plan will face limitations on distribution until the agent's commission is amortized within the insurer's internal accounting. It has the advantage of state insurance fund guarantees, regulated accounting practices, and ease of understanding, especially compared to some of the hedge funds, real estate partnerships, and other investment programs being sold.

Good luck with your decision.

[Guest Biggie]

Thanks for the help.

It just seems that everyone I speak to has something to sell. I've consulted with a couple of "pension specialists" in the area and they weren't very helpful. I agree that buying life insurance in the DBP is probably not the best idea, but there is something to be said for security and relative ease of it. Now is there really a tax benefit in purchasing universal insurance? I thought I would be avoiding taxation if I purchased universal insurance throught the DB plan.

And has anyone actually swapped their insurance policies out of their DB plan and cashed out?

[rcline46]

The rules for purchasing life insurance in a Qualified Plan can be complex depending on your corporate structure (sole proprietor, Sub S, C Corp, partnership, LLC,...) , the type of insurance purchased, and the contribution to the plan.

A firm which has had experience with life insurance in a Defined Benefit Plan is best suited to answer these questions. An insurance agent today is probably the person with the least knowledge.

The sole advantage of buying insurance in a plan is to pay premiums with pre-tax money (but you will have at least PS 58 income), and when you take it out, you get the insurance at the interpolated cash reserve (IRS value of the insurance). You also get a cost basis of the accumulated PS 58 costs.

If you are being sold a Defined Benefit 412(i) plan, no actuary needed! be forewarned that the IRS views many of these plans as 'listed transactions' which means an illegal tax shelter.

ASPPA (www.asppa.org) might give you a list of Enrolled Actuaries in your area. Other actuarial firms might also do so. If your tell us where you are some of the EAs on this board may contact you.

[Jim Norman]

First things first - do you actually need additional life insurance?

If no, then you shouldn't buy it, either in a pension plan or not. It carries an expense that you do not need to pay if you don't need the insurance.

If yes, why do you need the insurance?

If for estate planning and liquidity, probably best to buy insurance through an irrevocable life insurance trust, so that the proceeds are not part of your estate.

If for support of spouse and dependents, insurance held in a pension plan can work, but it may have little economic advantage.

Next, do you have other employees? If so, you probably don't want to fund the plan with life insurance as you have to provide the same for all other employees in the plan. This gets very expensive as the employees come and go and you are left with little or no value in the policies as they are surrendered in a relatively short time.

You mention "swapping out" the policy down the road. This suggests that someone is talking to you about buying insurance in the plan and later buying it out of the plan. This was a popular technique for a while, the tax advantage arose by buying the policy out of the plan for its "cash surrender value" which was often a very low amount due to surrender charges imposed by the insurance company. Within a few years, the surrender charges went away and the policy was worth a lot more. IRS has effectively shut this down, requiring that any such policy purchase be done at a fair market value, not surrender value. Failure to do so can disqualify the plan resulting in taxation and penalties.

You ask about "avoiding taxation". It is difficult to avoid taxes, basic rule of insurance, premiums are NOT tax deductible, proceeds paid on death are NOT taxed. Buying insurance in the plan, the plan pays the premium with pre-tax dollars. But as an individual plan participant, you get taxed on the value of the insurance benefit each year (sometimes referred to as P.S. 58 or table 2001 cost). So you are paying some tax on the insurance even within the plan. Insurance agents will also talk about getting tax-free withdrawals from the policy via policy loans. This can work, as long as the policy is kept in effect until your death, so the tax-free insurance proceeds pay off the loans. If the policy is canceled before death you get taxed on the policy loans as income.

[AndyH]

This sounds like what was proposed was an aggressive 90's style 412(i), read "Listed Transaction" to me.

[Guest GMP]

If you place yourself in the hands of an insurance agent he will make his money off of the insurance he sells you, and you will still need to have an actuarial valuation each year. If you place yourself in the hands of a financial advisor he will make his money off of the assets you invest with him, and you will still need to have an actuarial valuation each year. Since the bottom line in the care and feeding of a defined benefit plan is the actuarial valuation, talk to an actuary first. If you do not know how to find a reputable actuarial firm just post the name of your city and I'm sure some people here can offer recommendations.