Incidental Limit calc on premium or just cost

[Tina W]

When calculating the Incidental Limit on Universal Life Insuarance for a Money Purchase Plan, do you use the full amount of the premium paid or only the cost of the actual insurance?

I have been calculating the limit on the full premium for my plans. I recently recieved a Money Purchase plan that lowered their contribution amount and now the premiums exceeded the 25%. I submitted a question to a technical answer group and they are stating that the Incidental Limit should be calculated on the cost of the insurance and we should not include the portion of the premium that goes toward the investmnet component of the policy.

[shERPA]

Full premium, IMO.

Otherwise why would there be a different limit (25%) for term vs. a 50% limit for whole life. The assumption is 1/2 the WL premium goes to CV.

If it was calculated on the cost of insurance only there would be just one limit regardless of policy type.

[Bill Presson]

The key here is the type of insurance. shERPA is right on the difference in the limits. But universal life is considered to be term insurance so it falls under the 25% limit and you only use the cost of insurance.

[Belgarath]

Bill, do I understand you to be saying that, for example, a Universal Life policy with a premium of 10,000 (and let's assume the $10,000 falls within the 25% limitation) but that has an internal "cost of insurance" of, say, $3,000 in year one, that you only count $3,000 towards your incidental limit testing? Or is that not what you are saying, and you are saying that you would test using the $10,000?

I would suggest that anyone contemplating use of the $3,000 interpretation might be well advised to seek counsel before doing it. Aside from any interpretation of regulatory guidance, in the audits I've seen the IRS will treat the $10,000 as the "premium" subject to the 25% limitation.

[Bird]

I agree with what (I think) others are saying - UL us treated as term for this purpose; 25% limit.

It isn't entirely logical (one could dump a lot of excess money into a UL policy so the "premium" is more than a similar while life policy) but that's the way it is.

[ETA Consulting LLC]

It isn't entirely logical (one could dump a lot of excess money into a UL policy so the "premium" is more than a similar while life policy) but that's the way it is.

You're right, it's the "rose by any other name" situation. Written in the underlying definition of "Insurance", there is one thing it is not; an investment. The UL is designed, however, to meet the legal definition of insurance while providing an investment component. Even outside of a qualified plan, the policy itself as income tax deferral on the gains in the contract.

Good Luck!

[Tina W]

Here is the response I received from the TAG website.

The limit for term life insurance policies is (less than) 25% of the contribution. This is because term life insurance has no cash value; it is strictly death benefit protection. All other limits applicable to life insurance in qualified plans is derived from this basic 25% limit. I'm not aware that IRS has specifically ruled on universal life insurance. However, since the 25% limit applies to the incidental benefit (the pure life insurance), the amount of a premium that goes towards a plan investment (of any type) is not included in the 25% incidental benefit limit, because a plan investment is not an incidental benefit. This is why the limit applicable to whole life insurance premiums is (less than) 50%. IRS deems half of a whole life insurance policy premium to go towards the cash value of the policy. The other half of the premium is an investment of the plan, and therefore is not included in determining the incidental benefit limit; it is not an incidental benefit.