412i plan

[Gary]

Just a quick comment before further analysis:

One of my beliefs to date is that a 412i plan can be funded where 50% of total premium is for annuity contract and 50% of total premium is for life insurance, thus not violating the exceeding 50% of total costs requirement of 74-307.

Is that one approach that is satisfactory?

Cost of life insurance. 412i plan is for the two owners (husband and wife) and only employees of company. Is it always required that a cost of life insurance protection be reported as taxable income per nitice 2002-8 currently or are there situations where cost of insurance is not required or reported as income to participant?

Thanks.

[rcline46]

Cost of insurance - if the PS 58 cost is not reported as taxable income, pray that no one dies. If not reported and there is a death, ALL of the insurance proceeds are now taxable - bummer.

[Gary]

So if plan in force for 5 years for an owner and he did not report PS 58 cost till now he would have to catch up on reporting this income? Either by amended returns or some other way?

Thanks

[Mike Preston]

Just a quick comment before further analysis:

One of my beliefs to date is that a 412i plan can be funded where 50% of total premium is for annuity contract and 50% of total premium is for life insurance, thus not violating the exceeding 50% of total costs requirement of 74-307.

Is that one approach that is satisfactory?

Not necessarily. Somebody who knows how the calculations work still has to verify that the 50% spent on life insurance is within the boundaries established by 74-307.

[Gary]

In looking at 74-307 the 2nd to last paragraph says

"Accordingly, death benefits under a pension plan of any type will be considered incidental within the meaning of section 1.401-1(b)(1)(i) of the regulations if either (1) less than 50% of the employer contribution credited to each participant's account is used to purchase ordinary life insurance policies on the participant's life,...

So if 50% of the contribution is used to purchase life insurance and 50% of the contribution is used to purchase an annuity contract (if a 412i plan) or into a reserve fund if a traditional plan it would appear to compy with the above statement?

Thanks

[SoCalActuary]

In looking at 74-307 the 2nd to last paragraph says

"Accordingly, death benefits under a pension plan of any type will be considered incidental within the meaning of section 1.401-1(b)(1)(i) of the regulations if either (1) less than 50% of the employer contribution credited to each participant's account is used to purchase ordinary life insurance policies on the participant's life,...

So if 50% of the contribution is used to purchase life insurance and 50% of the contribution is used to purchase an annuity contract (if a 412i plan) or into a reserve fund if a traditional plan it would appear to compy with the above statement?

Thanks

You need to be very clear - ordinary life insurance has a specific meaning. It is level payment cash value life insurance.

Universal life policies are not subject to the 50% rule. Variable life policies are not.

[Gary]

Don't think 74-307 defines ordinary life insurance. I certainly know that 412i requires level premiums.

By the way I was trying to obtain prior rev rulings on line and I can't find them. Their of course old ones such as 74-307 (though have hard copy), 54-51, 68-403, 73-501, etc.

Google doesn't do it.

Any suggestions as to h ow to obtain old rev rul?

Thanks.

[Belgarath]

I have a book that I treasure - it is from Prentice Hall Information Services - 1990 edition. It is Entitled "Pension Revenue Rulings" and has all the pre-1990 RR's that affect pension plans.

I don't know if there is some way that you can find this or something similar. I haven't looked into other methods, 'cause I was fortunate enough to "inherit" this from another old-timer in this business.

P.S. - with your taxable term cost issue - are they unincorporated? The "reporting" isn't specifically listed, per se, for unincorporated owners. The taxable term cost is instead not deducted. For example, sole prop with $45,000 contribution on his own behalf, $1,000 TTC. The owner only deducts $44,000 as a qualified plan contribution. So while he pays income tax on that $1,000, it isn't separately "reported."

[J2D2]

Don't think 74-307 defines ordinary life insurance. I certainly know that 412i requires level premiums.

By the way I was trying to obtain prior rev rulings on line and I can't find them. Their of course old ones such as 74-307 (though have hard copy), 54-51, 68-403, 73-501, etc.

Google doesn't do it.

Any suggestions as to h ow to obtain old rev rul?

Thanks.

Try Legalbitstream.com

[SoCalActuary]

There is a difference between term and ordinary life policies.

See this wording in 74-307:

Section 1.401-1(b)(1)(i) of the regulations states that a qualified pen­sion plan may provide for the pay­ment of incidental death benefits through insurance or otherwise. Rev. Rul. 61-164, 1961-2 C.B. 99, and Rev. Rul. 66-143, 1966-1 C.B. 79, state that a 50 percent contribution used to pay premiums on ordinary life insurance policies is equivalent to a 25 percent pure insurance cost since only approximately one-half of the premiums paid for such policies are for pure insurance protection.

Ordinary life or term life were the only choices when this rule was issued.

Ordinary life really meant whole life policies or endowment policies that matured at some age with the full cash value equal to the face amount. In the period before ERISA, this was the primary product sold by insurance agents for retirement savings.

Some of us remember that Universal Life policies were not even available in 1974. My first exposure was in about 1981. Once the IRS understood them clearly, UL policies were subjected to the same rules as term policies, essentially the 25% premium method.

[Belgarath]

Gary - I forgot to mention that I don't know about resources for getting these old ones for free, but CCH has a VERY good on-line service that you could subscribe to.

[SoCalActuary]

Don't think 74-307 defines ordinary life insurance. I certainly know that 412i requires level premiums.

By the way I was trying to obtain prior rev rulings on line and I can't find them. Their of course old ones such as 74-307 (though have hard copy), 54-51, 68-403, 73-501, etc.

Google doesn't do it.

Any suggestions as to h ow to obtain old rev rul?

Thanks.

Try Legalbitstream.com

Your suggestion was great. I am adding them to my bookmarks. Thanks.

[Gary]

Thanks for the help.

Back to this matter re: 74-307.

74-307 addresses the less than 50% of total costs for life insurance and that the pure cost of life insurance cannot exceed 25% of total cost.

I have seen the IRS do an analysis that is not in my opinion exlicitly or implicitly stated in 74-307 and that is to determine a "theoretical contribution" and that the premiums cannot exceed 66% of this theoretical contribution.

Does anyone know where this method comes from and where it is documented?

thanks.

[Mike Preston]

The documentation is a series of Revenue Rulings (Rev. Rul. 60-83, Rev. Rul. 66-143, Rev. Rul. 74-307, Rev. Rul. 83-53, Rev. Rul. 85-15 and there are others referenced within the bodies of those rulings), which taken together state that the old principle of allowing 50% of the contribution to purchase whole life and 25% of the cost to purchase term or variable with respect to profit sharing plans is extended to db plans only if you calculate said 50% or 25% with reference to the ILP cost of the naked retirement benefit (not with reference to the actual contribution to the plan). Proof of this is in the LRM's at http://www.irs.gov/pub/irs-tege/db_lrm.pdf. See page 125.

Blinky did a calculation here: http://benefitslink.com/boards/index.php?s...st&p=107816

[Gary]

Thanks this all should be of help.

[Gary]

Changing gears a little.

One of the limits as I am learning is 66% of the theoretical contribution can be used to purchase a whole life policy and 33% for a term life.

The understanding is that the "pure insurance cost" cannot exceed 33% of the theoretical contribution.

So if the theoretical contribution were 90,000 than the pure insurance cost could not exceed 30,000.

Can this pure insurance cost be computed even for a whole life policy? I don't see why not.

For a whole life policy in the first year is it reasonable to compute the pure insurance cost as the face amount multiplied by the probability of death in that year? What mortality table is reasonable to use? Most importantly I am inquiring about the methodology of the computation.

This would enable a whole life policy that pays to high a premiium to still meet the incidental death benefit if the pure insurance cost were low enough.

Thanks.

[Mike Preston]

I think you would have a hard time becoming an insurance commissioner. Either that, or insurance companies would have a hard time meeting long term liabilities. So, let me ask you a question: where does the concept of "reserves" fit into your equation?

[Gary]

Thanks Mike

My interpretation of your thread is that there are certainly additional costs above and beyond the precise cost of the face amount, such as expenses, fees, and other costs. My thought is that would all be tied to the investment return of the policy.

In any event, while I need to do more research, I am trying to determine if the pure cost of insurance approach can be used to support an incidental death benefit whith a whole life policy and how such cost of insurance should be computed.

For now I'll have to hold off on submitting my resume for the insurance commissioner position.

Thank you.

[Mike Preston]

Thanks Mike

My interpretation of your thread is that there are certainly additional costs above and beyond the precise cost of the face amount, such as expenses, fees, and other costs. My thought is that would all be tied to the investment return of the policy.

That is the difficulty. Each "side" of the policy has its own set of expenses, fees and costs. Separating them is almost impossible. And the very rough justice approach of the IRS saying that 50% of a whole life policy's premium is to be treated as the cost of insurance will rarely, if ever, correspond to what one would come up with if a building block approach was attempted.

You do realize that if you want to use a building block approach you are looking to essentially re-write 40 or so years of IRS practice?

I'm not saying that what you want to do is impossible, just that it is revolutionary. That is not necessarily a bad thing, either, of course. All new theories, whether revolutionary or evolutionary, have to start somewhere.

But if you are going to go down that path, you need to recognize that the IRS is not likely to go gently into the good night on this particular issue, given that the logical conclusion of your approach is to (greatly) increase the amount of insurance that could be considered incidental in the case of most participants. I suppose as the age of the participant increases, the opposite might be true.

[Gary]

Agreed.

[Gary]

The only source that I have seen this infamous 66% of theoretical reserve calculation is in the LRM for DB plans. LRM 52.

Does this apporach exist anywhere else? And what authority does the LRM for master and prototype plans hold?

Thanks.