Life Insurance Benficiary

[Guest mcw]

Does the beneficiary of a life insurance policy held in a 401(k) plan have to be the plan? Can the participant name an individual on the life insurance beneficiary form?

[Bill Presson]

The owner and beneficiary should both be the plan.

[Bird]

The owner and beneficiary should both be the plan.

Absolutely. Insurance proceeds should be thought of as just part of the entire participant's account. Think about the bad stuff that can happen if the (current) intended beneficiary is named on the policy, and the participant marries, divorces, remarries, etc., etc. where it is entirely possible or likely that the policy named beneficiary is simply not allowed under the terms of the plan or the law.

[jpod]

But, if the plan is the beneficiary, the tax-free benefit of the death benefit is lost, isn't it?

[Bill Presson]

But, if the plan is the beneficiary, the tax-free benefit of the death benefit is lost, isn't it?

Life insurance proceeds in excess of a policy's cash surrender value are excluded from income under Sec. 101(a) (Sec. 72(m)(3)©; Regs. Sec. 1.72-16©(2)(ii)).

[Guest mcw]

Let me be a little more specific with my facts. We found out after the fact that the insurance agent/participant put the wrong beneficiary on the life insurance policy. The beneficiary was a trust. I agree that the beneficary should be the plan and it has been changed so that the beneficiary is now the plan. The auditor has now asked me if naming the trust was a prohibited transaction or otherwise prohibited. I cannot find anything that says you can't name someone other than the plan as the beneficiary. In fact, some of the prohibited transaction exemptions imply that you can. For example, PTE 92-6 says that you can transfer life insurance to a relative if the relative "is the beneficiary under the contract." This would imply that the relative (not the plan) can be a beneficiary under the contract.

[Belgarath]

Well, I'll take a stab. I'm not aware of anything prohibiting the life insurance policy to have a beneficiary other than the plan. However, I don't think any PLAN would/should allow this, as the plans have specific beneficiary payment provisions in accordance with ERISA and the IRC - QPSA requirements, for example. Consider what happens if the policy names the participant's mother, or participant's child, as beneficiary, rather than the plan, without a valid spousal waiver. The PLAN will be required to pay a specified death benefit to the spouse, but will not necessarily have the funds to do it as contemplated when purchasing the life insurance. The legal fraternity would have to chime in here, but this seems to have Fiduciary breach written all over it.

I don't think any responsible Trustee/Plan Administrator would ever consent to the purchase of a life policy by the plan where the beneficiary on the POLICY is other than the plan. Each individual should have a beneficiary designation on file with the Plan Administrator which covers all plan benefits, which would include the life insurance. I think you will also find that most plans have language that specifies that the PLAN will be the beneficiary. If so, and the beneficiary is other than the plan, then you have an operational violation which must be corrected.

Additionally, and you'd have to check with some insurance companies on this, but it would seem prudent that they might refuse to issue a policy in a qualified plan where the beneficiary is other than the plan. But I dunno on this. Maybe they don't care, or monitor this.

[Bird]

I agree with Belgarath. It shouldn't have been that way, but it wasn't a PT or otherwise prohibited.

[J Simmons]

But, if the plan is the beneficiary, the tax-free benefit of the death benefit is lost, isn't it?

Life insurance proceeds in excess of a policy's cash surrender value are excluded from income under Sec. 101(a) (Sec. 72(m)(3)©; Regs. Sec. 1.72-16©(2)(ii)).

Those proceeds would be excluded from income of the death beneficiary for the life insurance, the Plan Trust--which is already exempt from taxation. Then when the Plan Trust in turn pays those proceeds to the death beneficiary for Plan benefits, that payment is taxable income to the death beneficiary for Plan benefits. I think that is what jpod is getting at when suggesting that naming the Plan Trust as the death beneficiary of the life insurance loses the income tax exemption that would apply if the death beneficiary of the life insurance as owned by the Plan Trust were the employee's survivor rather than the Plan Trust.

Perhaps the Plan trustees could require a Plan death beneficiary designation that would would specify that it does not apply to Plan benefits to the extent of death benefits from life insurance held by the Plan Trust on the life of the employee and also only applies if either the life insurance death beneficiary is the employee's 'surviving spouse' or that surviving spouse has waived/waives timely the QPSA and QJSA forms of benefit.

[Belgarath]

John - could you please clarify your response? It sounds like you might be saying the death benefit, when paid from the plan to the participant's plan beneficiary, is taxable, but I suspect that's not what you meant to say at all?

[J Simmons]

John - could you please clarify your response? It sounds like you might be saying the death benefit, when paid from the plan to the participant's plan beneficiary, is taxable, but I suspect that's not what you meant to say at all?

No, Belgarath, as wrong as my statement is, it was what I intended. Good to learn the plan's handing over the death proceeds, over the csv is a tax-free distribution to the plan's death beneficiary.

[jpod]

JSimmons: Now I'm confused. Are you agreeing with me or not? If the death beneficiary is the plan, Section 101 is irrelevant because the plan is a tax-exempt entity. What I was saying was that once the death proceeds become an asset of the plan, there is no provision of the Code that causes any amount of those proceeds to escape normal Section 72/402 tax treatment once they are paid to the plan beneficiary(ies). Am I wrong about that? (Maybe I am because it's been a while since I had to consider the issue.)

[Bill Presson]

JSimmons: Now I'm confused. Are you agreeing with me or not? If the death beneficiary is the plan, Section 101 is irrelevant because the plan is a tax-exempt entity. What I was saying was that once the death proceeds become an asset of the plan, there is no provision of the Code that causes any amount of those proceeds to escape normal Section 72/402 tax treatment once they are paid to the plan beneficiary(ies). Am I wrong about that? (Maybe I am because it's been a while since I had to consider the issue.)

Not to be rude, but I already answered this above and even gave the specific treasury regulation.

"Life insurance proceeds in excess of a policy's cash surrender value are excluded from income under Sec. 101(a) (Sec. 72(m)(3)©; Regs. Sec. 1.72-16©(2)(ii)). "

[jpod]

Bill Presson: Are you saying that the rule and reg. you are citing applies to distributions from a qualified plan that could somehow be traceable back to life insurance proceeds paid to the Plan? If so, where exactly in what you have cited does it say that? I looked and can't find it.

[J Simmons]

Rev Rul 73-338 applies Treas Reg section 1.72-16©(2)(ii) in the way Bill Presson implies. Albeit the language of the reg itself does not make it clear whether it is the widow, for example, that gets tax-free the handover from the plan trust of insurance death benefits or it ought just be the plan trust that receives such tax-free. But since the plan trust is already tax exempt, it would be a bit redundant of the reg for it to be interpreted to not apply to the widow.

[mbozek]

Rev Rul 73-338 applies Treas Reg section 1.72-16©(2)(ii) in the way Bill Presson implies. Albeit the language of the reg itself does not make it clear whether it is the widow, for example, that gets tax-free the handover from the plan trust of insurance death benefits or it ought just be the plan trust that receives such tax-free. But since the plan trust is already tax exempt, it would be a bit redundant of the reg for it to be interpreted to not apply to the widow.

Since the reg specifically states that the exemption applies to LI proceeds in excess of the cash value paid to the beneficary of the LI contract, why isnt the exemption limited to the trust who is the designated beneficary under the LI policy, not the beneficary under the plan who receives the proceeds from the trust, the same way that that a distribution of an IRA to paid to the owner's estate as the designated beneficiary which then pays the funds to a spouse is not eligible for a tax free rollover, unless the facts meet an exception which permits a spousal rollover. Which brings up the interesting question of whether the IRS has ever issued a PLR allowing LI death proceeds that are paid tax free to the plan trustee as the beneficiary of the LI are deemed to be tax free proceeds under reg 1.72-16©(2)(ii) when paid to the deceased employee's designated beneficiary under the plan.

[J Simmons]

PLR 8307142, 11/22/82