Another question about life insurance in a plan

[katieinny]

A participant in a DC plan purchased a large insurance policy (2nd to die) with his plan assets. The beneficiary of the policy is an Irrevocable Life Insurance Trust. The plan is the owner of the policy, but not the trust. When the participant dies, would those assets be part of his taxable estate?

[J Simmons]

Interesting question. Here are some musings off the top of my head. To be part of his taxable estate, he must have owned the life insurance at the time of his death or had sufficient control over it to render him a de facto owner. He likely has, per the terms of the plan, the right to change who the death benefit is, and may do so right up to the time of death. In fact, the anti-alienation rule may prohibit him from being able not to have that power right up to the time of his death. So I do not think naming an ILIT will work to avoid the value of the life insurance from being in his estate.

[katieinny]

Thanks for your thoughts. I was able to find a section on the subject in Natalie Choate's book. She says it's "risky" to go that route to keep assets free from estate tax.

[Bird]

Generally speaking, plan assets, including insurance policies, are in one's estate. But a plan is often where the commission money, er, premium money, is found, so the insurance industry came up with a "subtrust" concept that supposedly left the policy in the plan but got the policy out of the estate. Supposedly this was "approved" by the IRS but I was/am skeptical. I haven't paid much attention in 10 years or so and don't know if there is something more definitive.

If the plan doesn't have special language creating a subtrust and having the policy bought and owned by it, then the policy is definitely in the estate. If it does, then...maybe.

[Belgarath]

Most folks I've talked to, including those in the insurance industry, didn't/don't think much of the subtrust concept and didn't/don't allow it in plans they administer. I did see a TAM back in 2006 where a defined benefit plan was DISQUALIFIED for using a subtrust. Whether this was due to subtrusts in general or defects in the particular subtrust involved, I can't say. The TAM was not yet numbered back then, so I can't provide you with a reference.

[katieinny]

Bird: I certainly agree that use of a subtrust to get out of paying estate tax is risky when it comes to a qualified retirement plan. However, I lost you at the last paragraph starting with "if the plan doesn't have special language...." The plan allows participants to self direct their investments and life insurance is permitted. The fact that the beneficiary of a life insurance policy is an ILIT wouldn't have to be permitted in the plan document would it?

[mbozek]

Bird: I certainly agree that use of a subtrust to get out of paying estate tax is risky when it comes to a qualified retirement plan. However, I lost you at the last paragraph starting with "if the plan doesn't have special language...." The plan allows participants to self direct their investments and life insurance is permitted. The fact that the beneficiary of a life insurance policy is an ILIT wouldn't have to be permitted in the plan document would it?

In order to have the LI removed from his estate the insured employee must give up all of the incidients of ownership in the LI including the right to designate the beneficiary, right to surrender or cancel the policy and the right to obtain a policy loan. What does the plan say about the ownership of these rights? Merely designating an irrevocable trust as the beneficiary of the LI does not serve to transfer the LI policy out of the employee's estate.

In estate planning the LI policy is removed from the insured's estate by having the owner apply for a policy that is owned from inception by the ILIT which is controlled by an independent trustee who pays the premiums to the insurance co.

[Bird]

Bird: I certainly agree that use of a subtrust to get out of paying estate tax is risky when it comes to a qualified retirement plan. However, I lost you at the last paragraph starting with "if the plan doesn't have special language...." The plan allows participants to self direct their investments and life insurance is permitted. The fact that the beneficiary of a life insurance policy is an ILIT wouldn't have to be permitted in the plan document would it?

I was trying to say the for estate tax purposes, if there was no subtrust in the plan, then there's no doubt in my mind that the policy is in the participant's estate, just like any other plan asset. As for the beneficiary designation, no,I don't think the plan itself has to have special language permitting an ILIT as beneficiary. (But I don't think the policy beneficiary should be the ILIT - I always want the plan to be owner and beneficiary of the policy, and have the participant's beneficiary designation then control where the proceeds ultimately go. FWIW.)