Basic life insurance question

[Santo Gold]

1 Life PS Plan with only the owner in the plan.

He has $300,000 invested in mutual funds plus an insurance policy that has $100,000 in cash surrender value; everything is pre-tax.

He wants to terminate the plan and roll over all assets into an IRA.

I believe that the insurance cannot be rolled into and IRA. Therefore, the only options are to:

(1) either cash in the policy (while still in the plan) and roll the cash value of the policy into the IRA along with the other non-insurance assets, or

(2) take personal ownership of the policy outside of the plan.

Questions I have in regard to Option #2:

** We are told that in order to avoid any tax consequence on the insurance, that the individual must contribute $100,000 in after tax-money into the plan. By doing so, this "balances" the idea that the cash value in the insurance policy, now held outside the plan, is not taxed now (at the time of distribution) nor at a later date when/if the participant wishes to terminate the policy and receive the cash value. In addition, the plan now has $400,000 in non-insurance assets in the plan and can roll the entire amount over into the IRA.

Is this the correct way that these are handled?

** If the participant does not want to pay the $100,000 into the plan but still take personal ownership of the policy, he can do that, but the cash surrender value becomes fully taxable when the policy is transferred out of the plan.

Does that sound right?

Thanks for any replies.

[Belgarath]

A couple of items to consider:

Your options are basically correct, but watch out for the technicalities. It is better to think of "Fair Market Value" when discussing these issues. While the FMV may be identical to the cash surrender value (CSV) it also may not. Check with the insurance company.

Another option (and I'm making no recommendations) is for the Trustee to take a maximum loan on the policy prior to assigning the policy to the individual. This allows most of the cash to remain in the plan to be rolled to an IRA, while getting policy ownership (albeit with an outstanding loan, which may or may not be acceptable) to the individual. But this does minimize or eliminate taxation while getting the policy to the individual without their having to come up with $100,000 to pay to the plan.

Make sure you get all your ducks in a row prior to initiating anything - some insurance companies who only dabble in the qualified plan market don't have service areas that really know what they are doing on such transactions.

[Bird]

I agree with Belgerath - taking a loan from the policy avoids the tax/cash flow problems, at least in the short run. In the long run, since you wind up with an extra $100,000 in the IRA in this example, you can take that out over a period of years and use the withdrawals to repay the loan. The money winds up being taxed but at least it is spread out.

And don't forget that there should be accumulated PS-58 costs that can be recovered tax-free. Just throwing numbers around, if the policy is worth $100K, there might be $10k of accumulated PS-58s. So you borrow $90K and distribute the policy, now worth $10K, but it's tax-free.

[Belgarath]

Agree with one potential caveat - unincorporated owners don't get to recover the taxable term cost. OP didn't specify if this was incorporated or unincorporated plan, so can't tell if this is recoverable or not.

[ETA Consulting LLC]

unincorporated owners don't get to recover the taxable term cost.

"Like". "Like". "Like". <- This is me hitting the "Like" button

This is because there is no accumulated cost basis (economic benefit basis) for the unincorporated owner.

[Guest rex]

you may wish to investigate the NITR and PERC values as discussed on this page...in essence NITR values are very close to cash surrender values and PERC values are very close to total premiums paid.

http://www.bsmg.net/eblasts/2010-4TransferringOwnership.html