Insurance in Plan

[cpc0506]

I have a client who owns an insurance policy for an employee and wants the 401(k) plan to take possesion of the policy. Is this allowable (assuming the plan allows for insurance)?

What would need to be done if this is even allowable? What steps must be taken to insure compliance?

[ETA Consulting LLC]

There is a prohibited transaction exemption for a plan purchasing a life insurance policy from a participant who is the insured. The plan would write a check to the participant for the fair market value of the policy. The insurance policy would be re-titled with the plan as the owner and beneficiary.

Good Luck!

[cpc0506]

I have just learned that the annual Premium for the policy is $18,000 a year. Doesn't this amount become more than an incidental benefit?

[Bill Presson]

I have just learned that the annual Premium for the policy is $18,000 a year. Doesn't this amount become more than an incidental benefit?

The 25% or 50% limit is based on total contributions to the plan, not just the current year. That total does not include rollovers.

[ETA Consulting LLC]

And, you also account for 'seasoned', or in some instances (arguably) 'seeded' money to provide more purchasing power.

Good Luck!

[cpc0506]

What do you mean by 'seasoned' money? Does that include earnings or just contributions?

Also, the plan is a KSOP. So I would think that the only funds available for purchase of the policy would be everything except the compnay stock 'owned' by the partcipant.

Also in your first response to me, you stated "The plan would write a check to the participant for the fair market value of the policy." Do you mean that they would write a check to the employer as the employer holds the policy for the participant?

[ESOP Guy]

All these questions point to why you keep this stuff out of the plan.

You may know this already but just in case. The plan will have to issue a 1099-R every year for the PS52 costs of the insurance. The insurance company can get you the PS52 costs. This creates an after-tax basis in the plan if I remember correctly. Adjust your fees for the new forms you have to do! Don't forget to track those PS54 costs will increase fees.

Don't forget to change your fees to reflect the fact you will have a Sch A in the plan.

What happens in a year the person doesn't have $18,000 in his 401(k) account? May not be a problem as they might have so much money now it will never get that low. But if it could happen does the plan sell stock to fund the payment? Could that require the sponsor to have to put money in the ESOP portion of the plan to keep it liquide just to this person can have life insurance in the plan?

Maybe these kinds of questions will help convince the plan sponsor to keep it out of the plan. Unless of coursse the plan sponsor is pretty much the same person (ie business owner) as the person who wants to put the insurance in the plan.

Can anyone tell I am not a fan of life insurance in qualified plans?

[ETA Consulting LLC]

^{The concept of 'seasoned' money is amounts that may be used to purchase life insurance for which the incidental limits do not apply. There are, actually, situations where it would be very beneficial for a participant (i.e. small business owner) to purchase a life insurance policy within a plan as opposed to purchasing it outside the plan. It is true that such an advantage may be available in limited instances, but there are instances. With that said, there are too many instances where an agent or advisor makes a suggestion to a client to purchase a policy within a plan without considering pros or cons against the approach. At the same time, there are those that say 'never' purchase a policy inside a plan; which they may be often right, but not alway right. You must know what you're attempting to accomplish from an insurance need and income tax strategy.}

^{Good Luck!}

[MWeddell]

There also is a fiduciary concern about whether investing in life insurance is a prudent investment, regardless of the fact that the participant is asking the plan to accept this earmarked investment.

[GMK]

you will have a Sch A in the plan.

Do not overlook the potential hassle and time-wasting this can have on 5500 reporting, especially if you are dealing with a firm that is too big to fail, which means they are too big to answer your question that you faxed repeatedly month after month, a level of disregard repeated in several different years...grumble, grumble, grumble...until one day you find a way to get rid of those investments in your plan, and you smile again. Just saying. I wouldn't wish such treatment on anyone. Thanks for letting me vent.

[ETA Consulting LLC]

Remember, there is no one size fits all. Many of these comments are valid; especially when the insurance issuer's employees aren't versed in any of the qualified plan rules. As a line employee, it's troubling when you can easily complete a report (i.e. 5500) but have trouble ascertaining the information allowing you to do so. This should generally be reflected in a premium for having insurance in the plan; and typically is. The issue is that you, as a line employee, generally do not receive extra pay for dealing with this stress. Very valid points.

However, there are still some instances where insurance in the plan is beneficial to the participants from that liquidity and tax perspective. In some situations, especially when the insured is a high-risk, purchasing the policy within the plan (mathematically) provides greater leverage. This leverage should be enough to pay the increased administration costs for having the insurance in the plan.

Good Luck!

[Bill Presson]

^{The concept of 'seasoned' money is amounts that may be used to purchase life insurance for which the incidental limits do not apply. There are, actually, situations where it would be very beneficial for a participant (i.e. small business owner) to purchase a life insurance policy within a plan as opposed to purchasing it outside the plan. It is true that such an advantage may be available in limited instances, but there are instances. With that said, there are too many instances where an agent or advisor makes a suggestion to a client to purchase a policy within a plan without considering pros or cons against the approach. At the same time, there are those that say 'never' purchase a policy inside a plan; which they may be often right, but not alway right. You must know what you're attempting to accomplish from an insurance need and income tax strategy.}

^{Good Luck!}

The reason that the incidental limits "do not apply" when you use seasoned money is because the entire transaction is taxable.

[Belgarath]

"The reason that the incidental limits "do not apply" when you use seasoned money is because the entire transaction is taxable."

Personally, on this question I'd refer them to their ERISA attorney. There is some disagreement even among ERISA attorneys on this question - possibly depending upon who is paying them, but that may be an unfair observation, so don't give it any credence.

Although Jim Holland opined this from the podium many years ago, I've yet to see any enforcement of this as official IRS policy, and I've seen many plans pass audit without it even being questioned by the IRS.

It certainly isn't for the faint of heart, and the unquestionably safe/conservative position is not to do it without the client having received an opinion from an ERISA attorney.

[ETA Consulting LLC]

I've seen the arguments on that, but there is nothing written in the statute to support that. The concept of "incidental limit" is not a tax issue, but a qualification issue; the plan may not exist for the purpose of purchasing insurance. Instead, the plan is established for providing a retirement benefit for participants (and beneficiaries); the existence of insurance must be "incidental" to that purposes of the plan.

There is no change in taxation from whether the benefit is incidental (or not). This is merely a limit to preclude someone from establishing a plan in order to purchase the life policy they want. BTW, there is really no requirement that you issue a 1099-R each year on the economic benefit of the insurance. However, if you don't, then the participant's beneficiary will not receive the death benefit (calculated at the net amount at risk portion) on a tax-free basis.

Life insurance in a qualified plan is potential complex. We have components in the industry that will argue you should never let this happen and search for rules to support this. This severe case of confirmation bias often overreach on the way the rules are written. At the same time, many life insurance agents will say "always" do it. My suggestion is to do the math and apply the rules as written in each instance; and make a fully informed decision on whether it works for that individual in question.

Good Luck!