Excess insurance in a frozen defined benefit plan

[Guest SVogel]

A traditional defined benefit plan [not 412(i)] was frozen in 2003. There is an insured death benefit equal to 100 times the anticipated monthly retirement benefit less the cash surrender value of the insurance contracts. For several years the client has been advised to reduce the face amount of the insurance in the plan, but they have not done so. I believe that this constitutes a listed transaction which is reportable on Form 8886 and which is subject to an excise tax. I have two questions: 1) Is there an exemption for amounts up to $100,000 in excess such as there is with a 412(i) plan?; and 2) Is each policy in a given year counted as a separate listed transaction, or would it be considered one listed transaction for the plan for the plan year? With respect to the the first question, if anyone can supply a cite, it would be great.

[Mike Preston]

Check out IRS Notice 2009-59 for information on listed transactions. Specifically, the 27th item therein is:

(27) Situation 2 of Rev. Rul. 2004-20, 2004-1 C.B. 546, modifying and superseding Rev. Rul. 55-748, 1955-2 C.B. 234 (certain arrangements in which an employer deducts contributions to a qualified pension plan used to pay premiums on life insurance contracts that provide for death benefits in excess of the participant's death benefit, where under the terms of the plan, the balance of the death benefit proceeds revert to the plan as a return on investment) (identified as "listed transactions" on February 13, 2004)). See also Rev. Rul. 2004-21, 2004-1 C.B. 544, §§ 1.79-1(d)(3), 1.83-3(e) and 1.402(a)-1(a)(1) and (2), and Rev. Proc. 2005-25, 2005-1 C.B. 962, modifying and superseding Rev. Proc. 2004-16, 2004-1 C.B. 559;

mike

[david rigby]

http://www.irs.gov/irb/2009-31_IRB/ar07.html

[Mike Preston]

I don't think there is too much relevant in that Notice other than what I posted. It would be a "good thing" if the page you linked to had hyperlinks to the 2004 guidance, because that is where the details are.

[AndyH]

Mike or anyone else with knowledge of this, would you mind elaborating on this? I see this situation periodically as well. Does this say, among other things, that excess life insurance cannot be retained as a general asset of the Trust? And what are the penalty implications?

[Mike Preston]

It is a very choppy bit of guidance. In some parts you will see headers that indicate insurance in excess of a certain limitation will lead to problems even though the text of the guidance gives no such result and the examples specifically allow it.

You really need to read the 2004 guidance, in all its glory, to appreciate what is going on.

[Belgarath]

I'm going purely from memory here, but I do seem to recall that there was a $100,000 cutoff on this. If the "excess" face amount was less than 100,000 over the limit, then while you had a deduction problem, it wasn't a listed transaction. If the excess was more than 100,000, it threw it into listed transaction status, for which I believe they offered a limited amnesty period which is LONG gone. But as I said, this is from memory only, so please don't take my word for anything on this.

Now, if the plan is an IRS approved document, particularly if it received a D-letter, and the plan document allows "key man" insurance as a plan investment, then you'd have to talk with an ERISA attorney as to the litigation chance of success, if it get to that and if it is worth fighting. The auditing arm of the IRS sometimes has their own agenda which doesn't coincide with the arm that approves documents. Personally, I'd get the excess insurance the he!! out of the plan. But the listed transaction penalties are such that I think the client should definitely seek ERISA counsel before deciding on a course of action.