Life insurance as qualified plan investment

[Guest Sieve]

Any idea if a DC plan can purchase life insurance on the lives of participants as an investment only? In other words, any proceeds would simply be allocated to participant accounts & not paid to the insured's beneficiaries.

Questions in my mind:

• What about PS 58 costs? Are they allocated to all participants?
  
• Is there an insurable interest under state law?
  
• This happens to be a governmental plan. Any special issues (other than whether state law permits that type of investment)?
  

Any other thoughts, issues, questions?

[J Simmons]

Any idea if a DC plan can purchase life insurance on the lives of participants as an investment only? In other words, any proceeds would simply be allocated to participant accounts & not paid to the insured's beneficiaries.

Questions in my mind:

• What about PS 58 costs? Are they allocated to all participants?

Logically, there should be no PS 58 costs as the life insurance is not an economic benefit to any one participant in the way that it would be if death benefits were payable to that participant's loved ones.

• Is there an insurable interest under state law?
  

Since the death of a plan participant is a distribution trigger, and thus the plan then has an obligation to pay benefits, arguably yes the plan does have an insurable interest. The counter argument, if this is a DC plan we're talking about, is that it merely enhances the amount of benefits for all plan participants, and the other plan participants do not have an insurable interest in the life of another plan participant.

[QDROphile]

Additional question: If all your questions can't be answered with acceptable answers, is it a breach of fiduciary duty to have such investments? Even if ERISA does not apply, there are fiduciary duties, although enforcement and penalties in that cases I am familiar with are essentially nonexistent.

[jpod]

I have 3 questions to add to your list of questions.

1. Are we talking term insurance or something else?

2. If the former (or for that matter, even the latter), will the plan have sufficient liquidity to effect distributions to participants?

3. Since when did life insurance become a rational investment for someone (in this case, some thing) who doesn't need death benefit protection? Stated differently, how can the plan fiduciaries possibly justify this? Is a plan fiduciary's relative earning the commissions?

[Belgarath]

For a non-governmental plan, I don't see any possible way for this to be allowable in a DC plan.

For a governmental plan, I have no idea.

[Guest Sieve]

Would it make any difference if this was a DB plan and the proceeds were used to fund retirement benefits?

[jpod]

It would not make any difference to me.

[rcline46]

Now Sieve, if you change the rules, the answers change. Purchasing insurance on the owner for an underfunded plan just might be acceptable.

[Belgarath]

Again, in the context of a non-governmental plan...

Depending upon how you read Revenue Ruling 2004-20, I have my doubts that such "key person" insurance would be currently deductible. And the insurable interest issue that you raised might be an issue as well. Additionally, I have a hazy recollection that the IRS has been less than definitive in discussions from the podium, saying that there "may be" problems. I think there was some concern that using the proceeds would relieve the employer from otherwise required funding obligaions.

Depending upon the $$ involved, I think I might want a PLR before messing with this.

[Bird]

I've heard of this (key man life insurance)...as a matter of fact, my GUST documents expressly permit it:

"The Trustee, with the consent of the Administrator, may purchase insurance Policies on the life of any Participant whose employment is deemed to be key to the Employer's financial success. Such key man Policies will be deemed to be an investment of the Trust Fund and will be payable to the Trust Fund as the beneficiary thereof."

The insurable interest to the plan is that, without the key participant's existence, the plan's ability to continue and provide additional contributions and/or benefits is compromised.

PS-58 costs would not apply, IMO.

I'm not really sure about this in the context of a government plan.

[Ron Snyder]

* What about PS 58 costs? Are they allocated to all participants? No PS 58 costs.

* Is there an insurable interest under state law? Only on key employees.

* This happens to be a governmental plan. Any special issues (other than whether state law permits that type of investment)? No key employees typically.

Since the death of a plan participant is a distribution trigger * * * This is a red herring.

1. Are we talking term insurance or something else? Legally no difference.

2. * * *will the plan have sufficient liquidity to effect distributions to participants? A facts and circumstances test.

3. Since when did life insurance become a rational investment for someone (in this case, some thing) who doesn't need death benefit protection? Stated differently, how can the plan fiduciaries possibly justify this? As any deferred compensation actuary knows, life insurance can be a profitable investment with relatively stable investment yields. However, (i) the group must be large enough to be an true actuarial group (500 lives?); (ii) the tax benefit is lost in a qualified trust, reducing the effective net yield.

Is a plan fiduciary's relative earning the commissions? This raises a separate issue, the possibility of a prohibited transaction.

If all your questions can't be answered with acceptable answers, is it a breach of fiduciary duty to have such investments? Even if ERISA does not apply, there are fiduciary duties, although enforcement and penalties in that cases I am familiar with are essentially nonexistent. Another facts and circumstances test.

[Below Ground]

If I understand the preceding discussion, this means that a Plan could use as an investment a life policy on the life of a key person; which is not specifically attributed to that person's account/benefit under the Plan. In otherwords, the policy is simply an asset of the trust and applies to all member accounts. Is that correct?

If yes and premium is not part of a specific person's account, how are premium payments accounted for under the Plan? If they are a deductible contribution to whose account are these monies allocated?

[Bill Presson]

If I understand the preceding discussion, this means that a Plan could use as an investment a life policy on the life of a key person; which is not specifically attributed to that person's account/benefit under the Plan. In otherwords, the policy is simply an asset of the trust and applies to all member accounts. Is that correct?

If yes and premium is not part of a specific person's account, how are premium payments accounted for under the Plan? If they are a deductible contribution to whose account are these monies allocated?

The premiums would just be included in the trust accounting and aren't allocated to the participant accounts any more than the money used to purchase a stock are allocated to participant accounts. Money comes out of the trust and is replaced by a piece of paper representing a value.

They are not a deductible contribution because the money is already in the trust.

[Below Ground]

Thanks Bill. In this case there was a $1,000 premium that was paid by the firm. I am wondering how this $1,000 is accounted for under the Plan. Again, thanks for your reply.

[Bill Presson]

Thanks Bill. In this case there was a $1,000 premium that was paid by the firm. I am wondering how this $1,000 is accounted for under the Plan. Again, thanks for your reply.

I've always done better by thinking about it in a double entry bookkeeping system. Let's say you have $1,000 in a cash account. That's a debit balance. You decide to buy a life insurance policy as a key man policy for a $1,000 premium.

So, you credit the cash account $1,000 to eliminate that balance. You debit the new asset "life insurance" for $1,000 to record the purchase. Let's say at the end of the year, the surrender value is $500. So, you would credit the "life insurance" asset by $500 to "write down" the asset and debit an expense account "life insurance loss" to record the loss for the year.

Same thing each year as the policy is paid for.

[K2retire]

But it says that the premium was paid by the company, not the plan. So that cash asset that you're crediting is not part of the accounting for the plan. Now your double entry explanation is off balance.

[Bird]

We don't know if the plan is pooled or segregated accounts. If pooled, then treat the premium payment as a contribution. If segregated, then you'd have to somehow allocate a little bit of the premium to each participant as a contribution...but then, assuming the accounts are self-directed, where is the "direction" from each participant for this? It's not really practical for a self-directed plan.

We also don't know if it is term or whole life. We would expense term premiums, and treat whole life premiums as purchase of an investment, as Bill suggests.

[Below Ground]

Bird - I don't know if policy is whole, term or universal. (I am having some problems getting information. It is a takeover plan.) I do know that the policy owner is the trust and the insured is the firm's owner. No other policy is held for any other person under the Plan.

The fund holding this policy is a pooled fund. Related "investment experience" of the policy appears to have allocated under the pool as prorata to member balances which are held under the pool.

The firm paid an annual premium of $1,000 which does not look like it was applied to any employer contribution allocation. (The Plan allows for deferrals and the firm does a simple 25% Match.)

I was looking to see if this was a form of "Key Man Insurance", and if so was the premium payment a deductible expense instead of an employer contribution.

Honestly, I have not seen use of Key Man Insurance in well over a decade, so I am on shakey ground. Any insight would be appreciated.

[Bill Presson]

Bird - I don't know if policy is whole, term or universal. (I am having some problems getting information. It is a takeover plan.) I do know that the policy owner is the trust and the insured is the firm's owner. No other policy is held for any other person under the Plan.

The fund holding this policy is a pooled fund. Related "investment experience" of the policy appears to have allocated under the pool as prorata to member balances which are held under the pool.

The firm paid an annual premium of $1,000 which does not look like it was applied to any employer contribution allocation. (The Plan allows for deferrals and the firm does a simple 25% Match.)

I was looking to see if this was a form of "Key Man Insurance", and if so was the premium payment a deductible expense instead of an employer contribution.

Honestly, I have not seen use of Key Man Insurance in well over a decade, so I am on shakey ground. Any insight would be appreciated.

Sorry, I completely overlooked that the firm paid the premium. Obviously, it should have been paid by the trust and they need to understand that going forward.

It's not the first time that a business did this, although it has been a while since I've seen it. I would have to vote for allocating it as a ps contribution OR (maybe??) counting it toward the match amount?

[Bird]

Oh, now I understand that we have switched gears from the government plan with key man insurance to a private company with insurance of an unknown nature...

odds are pretty good that this is not key man insurance, just one participant (the owner) who "decided" (i.e. was sold) to buy insurance using his own account's money. It is proper that the trust be the owner and beneficiary, even if it is for the benefit of only one participant. Look at a prior year's val to see how the premium payment was treated; it was probably treated as a contribution to the owner's account - at least it should have been, so if his total contribution was 4,000, 3,000 went to the "side fund" (i.e. pooled account) and 1,000 went to insurance. Of course, there's always the possibility that it was overlooked and not included in the trust accounting at all; then you have a different mess on your hands. But it's ok to pay premiums from the plan sponsor directly to the insurance company; they are treated as contributions. I'd prefer that the trust pay the premiums, as a transfer within the trust, because if it goes from sponsor to insurance company you've locked in a minimum contribution.

[Below Ground]

Bird - Sorry for the confusion. I was trying to find a discussion that could provide insight toward the problem at hand. This was the closest to the topic that I found, so I guessed that related posters would be most likely have an understanding of the problem.

To put this problem in context, getting something like a prior valuation has proven to be impossible. What I have are financial account statements and an ADP/ACP Test. From these it appears that this policy was held for the owner as would be typical to the "side fund/life policy scenerio" described by Bird.

My concern that perhaps this is something else was due to the apparent omission of the premium payment under allocations of the plan. I can see the deferral allocation via testing and deposits, I can see the match allocation via testing and deposits, I can't see the premium payment being accounted for anywhere. I only know that the firm paid and deducted these monies. This made me think that perhaps this policy is something like "Key Man", a topic that is "rusty" for me.

I should also note that this policy is held in a pooled fund for which there does not appear to be any allocation or reconciliation between members. Yes, as clean-up work I will be trying to recreate a valuation. (I know -- good luck on determining a starting point.) :angry:

Given the insights already provided I am coming to the conclusion that I have that "different mess" that Bird alludes too. Having been in this business for a few years I am not surprised. Disappointed, but not surprised.

Again, thanks to everyone. Of course, additional comments would also be appreciated.