Insurance From DB Plans

[Guest naveen]

DB Plan is the beneficiary of an insurance policy with a face value of 1,000,000 with a cash value of 100,000.

Plan wants to assign the policy to the individual participant (HCE) and get the policy out of the plan. Currently owner is the only participant but he will be hiring some employees during 2010. Plan will be amended accordingly so as not to purchase insurance for participants.

How is this accomplished

Does the participant pay cash value back into the trust

Is “springing cash value” an issue?

[Belgarath]

First, as always, check the document to see what it says on the issue. But if there hasn't been some sort of a distributable event, then the participant needs to write a check to the plan for the fair market value. This may be the same as the cash value, or it may be higher. Client will need to check with the insurance company to find out. So a "springing" cash value policy isn't a problem per se, because participant would be buying it for the FMV, which would be a lot more than the CSV.

There are situations in small plan terminations, for example, where this can cause all kinds of problems, because it pumps a huge infusion of cash into the plan, and if the plan assets are already such that participant who is at 415 limit has that 415 limit already fully funded by existing assets, then the plan has excess assets, which can't be used up in some situations. So if you aren't the actuary, I'd recommend that you check this with the actuary to confirm that it will be ok in your situation.

[AndyH]

Belgarath,

May I ask a couple of followup questions for my information?

Will insurance companies actually state a "market value"? In limited experience, I have had trouble getting them to provide anything other than vash balue, accumulation value, etc.

Isn't the cost to the participant actually the greater of the CSV or the sum of premiums paid, interest, etc. that was outlined in the springing cash value promulgation by the IRS from several years ago, or is that not considered current thinking?

What is "interpolated terminal value", which I have been told should be the purchase cost? Is that similar to the premiums plus that I just described?

Why might a "market value" be significantly greater than the cash value, other than the obvious load or exense charge that should wear away over time? Is this like the opposite of what happens when Manny becomes a free agent, i.e. his market value is a fraction of his current contract value?

[SoCalActuary]

Manny???? Don't let him go. We got him in LA, and we want to keep him!

[Belgarath]

Hi Andy - you should be in a good mood these days - Red Sox Nation is happy right now!

I've never found it a problem to obtain (or to have the client obtain) FMV vs. cash value. Maybe I've just been lucky. The companies I've dealt with routinely will provide a FMV if the FMV is different from the cash value.

Cost to the participant would normally be the CSV, or if greater, the FMV. To elaborate, and get to your last question, many companies marketed policies which were designed for "rollouts" from the plan. By design, these policies had "suppressed" or low cash values in the early years, and the accelerated cash value growth hit after the policies were typically rolled out of the plan. The idea was that you would have a large income tax deduction for the premium, yet pay very little income tax when you got it out of the plan, then the cash value would grow very fast. The "springing" cash value type policies were rather gross examples of this practice, which is why the IRS clamped down in the first place. But to pluck numbers out of the air, if you paid $50,000 permiums per year, and after 5 years the cash value was $10,000, but in the next 5 years the CSV would grow to $750,000, then it would be a little unreasonable to accept the cash value as a true measure of the "fair" market value. If I were given the opportunity to purchase such an existing policy for $10,000, I'd sure grab it fast! Any reasonable person would say that the FMV in such a situation is obviously higher than $10,000.

I have no clear knowledge of what interpolated terminal reserve is, or how it is calculated. I only know that when determining a FMV, Revenue Procedure 2005-25 gives a safe harbor where the FMV is the GREATER of (A) the sum of the interpolated terminal reserve, any unearned premium, and a pro-rata portion of any current dividend, or (B) he product of the "PERC" amount and the "applicable average surrender factor." How an insurance product actuary (or whoever) actually calculates the FMV is something about which I have no clue whatsoever. I merely know they do. So the FMV figure that

the client is getting from the insurance company may well be "interpolated terminal reserve" for all I know - we just accept their figure.

[Jim Norman]

The one time I "rescued" a 412(i) plan, getting the FMV to get the insurance out of the plan was the single biggest problem. Took 6 months to get the ins company to give us the numbers for the RP 2005-25 safe harbor, they kept telling us the CV was the FMV and we kept sending them the Rev Proc.

Good luck.

[Guest naveen]

Thanks to all for your responses.

I wanted to confirm this had to be done in accordance with Rev. Proc. 2005-25.

[ScottR]

Just to add my 2 cents: Before "selling" the policy to the participant, the plan could borrow the maximum against it. That would reduce the net value of the policy, and therefore reduce the amount that the participant has to cough up in cash. Granted, he'd be getting a policy with a loan against it, but it might still make sense if cash flow is an issue.

... Scott