Term Insurance in 401(k) Plan?

[Dougsbpc]

We inherited a 401(k) plan (had been a profit sharing plan for years) where only the company owner has whole life insurance as part of his account balance. Apparently none of the other 7 participants had ever been offered insurance. The agent now wants to offer policies to the 7 participants. However, he wants to offer term policies. Is this possible? Would this not be a discrimination issue since the owner has whole life and employees would have term?

Thanks.

[ETA Consulting LLC]

Not necessarily. A purchase of life insurance is similiar to an investment election in the plan. The issue, here, is that the employees may purchase any type of life insurance policy they choose (either whole, variable, or term). They are likely being offered what they could afford, but not being precluded from purchasing anything. Each participant has his own election.

Good Luck!

[GBurns]

Dougsbpc

I am curious as to what you see as being discriminatory? Are you, by any chance, thinking that whole life is somehow better than or superior to term in this situation?

[Dougsbpc]

Thanks for the responses.

Yes. Would it not be discriminatory if the company owner had whole life and everyone else had term? Perhaps not if everyone was offered whole life and term and each made their choice?

Could an employee have the plan purchase / assume her term policy already in force or would this be a prohibited transaction? I know this often happens the other way around but such policies usually have cash value and the purchase price is related to the cash value.

[Bill Presson]

While I'm not a huge proponent of whole life insurance in plans (especially since it is never done correctly), I can see some times where it is appropriate.

But why have term in the plan? The PS 58 cost reporting is essentially passing through the premium payment, so I'm not sure of the benefit?

[Dougsbpc]

There is one employee in the plan who already has a term policy and her health is not the greatest. The agent wants the plan to be able to purchase her policy.

I guess what you are saying is that there is no advantage to term in a plan because the ps-58 cost will essentially be what the premium is.

[Bill Presson]

There is one employee in the plan who already has a term policy and her health is not the greatest. The agent wants the plan to be able to purchase her policy.

I guess what you are saying is that there is no advantage to term in a plan because the ps-58 cost will essentially be what the premium is.

Correct.

[masteff]

The agent wants the plan to be able to purchase her policy.

No, the agent thinks he can protect his commission and possibly add new commissions. My general rule of thumb: don't take advice from an agent who wants to sell any form of insurance as an investment.

During my 7 years in benefits administration, the worst misinformation I had to correct for participants came from insurance agents.

[MSN]

Is adding an option to buy term insurance prudent? Regardless of the availability issue raised, the fiduciary (I'll go out on a limb and assume the insurance rep is not a fiduciary) is responsible for ensuring that it is prudent to allow participants to "invest" in term life insurance in the plan. The payout figures on term policies are remarkable, with over 99% never paying a dime to owners/beneficiaries. It's more like a black hole than a legitimate investment.

Term life policies have a place in many individuals financial plans, but not inside the 401(k). I don't care much for whole life policies in plans either, but at least you could make a case for them as investments.

[QDROphile]

I second the concerns of MSN. The fiduciary responsible for investments must evaluate what options are available. If the fiduciary designates in investment options and would have to designate insurance as an option, the deisgnation is a very serious concern and substantive evaluation should be conducted to make sure that the option is prudent. It is less a concern if the fiduciary does not designate investment options because the plan (by design or fiduciary decision) has opened the plan to any legal investment. The fiduciary would have very little responsibility for the investment chosen by a particpant. The fiduciary might have to worry about the relationship of the agent pushing the policies.

[Bird]

While I don't care for any kind of insurance in plans, I don't think term is any worse than whole life. Of course term hardly ever pays off, that's why it's so cheap! It's not supposed to be an investment, it's a different kind of benefit that is allowed by law. I'm pretty sure that the next time action is taken against a fiduciary for just allowing insurance in a plan will be the first.

[Guest DeniseM1]

I would find out what would happen to your term insurance through your 401(k) should you lose your job or choose to quit. I agree, in this case (an investment scenario), a whole life policy would seem the better option. If the term insurance you’re being offered right now will remain unchanged in the future and you still desire whole life coverage, you can look for an independent policy outside of work. Again, if your search is investment oriented, many life insurance professionals urge looking at LI as protection in case of death or income loss alone. A whole life policy offers great returns if held in place for many years, and usually does not immediately reflect lucrative gains in financial markets.

Denise Mancini

Disclaimer: I work for AccuQuote and this is my personal opinion.

[Belgarath]

Let me start with the disclaimer that I'm with a TPA, and not affiliated in any way with any insurance company or product sales. So I think my opinion is objective. You may not AGREE with it, but it is at least objective.

I also am not a fan of insurance in plans, for a variety of reasons. That said, it isn't always bad. And while I shudder at the thought that this may give insurance salespeople another avenue for a "pitch" - consider the following situation:

You have someone with a family who really does need insurance coverage, but either cannot (or more likely doesn't want to) afford it out of current income. Let's assume for simplicity and purely for the sake of illustrating the point that their combined tax bracket is 25%, and the income of the sole wage earner is $50,000. So their money in pocket after taxes is $37,500. The premium for term insurance is $1,000, which is paid after-tax, and would leave them with $36,500 for their living expenses.

Now suppose the same person has a Profit sharing plan at work,to which the employer allocation on behalf of the participant is $4,000. Out of this, he purchases a term insurance policy with a $1,000 premium. He declares this $1,000 as taxable income, which increases his taxable income to $51,000. After paying his 25% tax, he has $38,250.00 left for living expenses - a $1,750.00 increase over what he had if buying the term insurance outside the plan. So not only does he have life insurance which he needs, but he has a net TEMPORARY increase in disposable income. In essence, a withdrawal from the plan that might not otherwise allow it or might otherwise be subject to premature distribution penalties.

Now, he's sacrificing future income for short term gain. But that's a personal choice - maybe he expects to have a financial situation that improves, and he's only doing this for the short term - whatever. I make no judgment on the motives or reasons I merely wish to play Devil's Advocate and point out that it isn't always evil.

I would have little or no concern over offering term insurance in terms of fiduciary duty or PT issues, as long as due diligence is used when selecting the company or companies from which such insurance would be available, and there is appropriate disclosure about the long term reduction in accumulation of retirement assets. Offering whole life insurance does raise such issues, which must be very carefully considered. Personally, if I were a fiduciary, I sure wouldn't allow it.

[Guest rex]

There really is almost no benefit to the client to offer permanent insurance within a qualified plan. It only helps the agent. While it initially is a large tax deduction, the policy can not be transfered to an ira and thus at some later point in time for most people, especially employees who might change jobs, it must be surrendered typically at a huge loss or purchased out of the plan for the correct fair market value. This value is very likely to be much more than the client can afford and thus they are forced to surrender the policy. Agents like to promote this since it gives people the illusion they can afford a higher value of permanent life insurance but unless the client dies while the policy is still within their qualified plan, that "benefit" isnt going to happen.

For term, it isnt such a big deal one way or the other but if the person is healthy then they almost always would be better off with an independent agent shopping their situation around then having to pay the price of the limited options within this 401k.

Denise you dont seem to research before promoting your ideas like you do here, on fatwallet, bogleheads, and even the insurance agent forum. You dont seem to understand the products you are selling yet you use your credentials to pretend that you do. Google 412e white paper to get an idea why it isnt such a great idea.

[Belgarath]

And after thinking about this for no particular reason, I realize I slipped a digit on my calculator. Darn those extra thumbs! They would have 37,250 left "in pocket" not 38,250. Ergo, the "gain" for purposes of living expenses would be 750, not 1,750. Sheesh. Nevertheless, the basic point remains.