insurance paid by rollover money

[thepensionmaven]

Two W-2 employees terminated from employer X profit sharing plan.

These two are also 50/50 owners of their own corp, which does not have a qualified plan.

Life insurance agent (of course) wants them to establish a profit sharing plan, take the rollover money to purchase ten- pay life insurance policies and make the plan the owner and beneficiary.

This just doesn't smell kosher.

Any thoughts?

[QDROphile]

Kosher or not, we advise not to hold life insurance in a qualified plan. Those who have experience in doing so may comment on the compliance issues, but starting out with so much insurance is a separate concern.

[Bill Presson]

Rollover money doesn't count in the incidental tests. So, unless they are making regular contributions, the premiums would be a taxable distribution.

It's still kosher, but the agent won't want to follow the tax rules.

[Belgarath]

I'll just say that there is some question as to whether the entire premium would be taxable, or whether just normal taxable term costs would apply. Or maybe I'm misunderstanding what Bill is saying in his post.

I'd be more concerned with establishing a PS plan, and funding it with just rollover money to purchase life insurance. Unless you have other, "recurring and substantial" contributions, then I think you have a potential qualification problem.

Thankfully, we have almost no plans that even permit life insurance, much less actually purchase it, which helps me to sleep at night.

[Bill Presson]

I'll just say that there is some question as to whether the entire premium would be taxable, or whether just normal taxable term costs would apply. Or maybe I'm misunderstanding what Bill is saying in his post.

I know there are some disagreements on the taxation of ps money that has been in the plan for more than two years and is used for premiums.

But I'm just talking about using rollover money and the interplay with the incidental rules. For a participant to get a 1099 on just the taxable term costs, the insurance premiums must pass the incidental tests. Let's just use the "less than 50% of the total contributions" test for these purposes.

In this instance the entire amount would be rollovers and (at least initially) there would be no contributions. If there were contributions sufficient to allow the premiums to pass the incidental test, I don't think we would be having this discussion.

In 1992, I sent an information request to the service to ask about several of these issues. The specific response related to this is: "Because rollover money is neither a 'contribution' nor a 'forfeiture', no portion of the rollover money is taken into consideration when determining the amount of premiums that may be used to provide an incidental level of insurance coverage."

So, I think it's pretty clear in the OP's situation as I understand it, that any money used to pay premiums would violate the incidental tests and would, therefore, be 100% taxable.

[Belgarath]

Hi Bill - again, without opining about correct vs. incorrect, I'll just say that there is a lot of legal talent out there that might disagree with you. And probably as much or more that agrees with you. There are (or at least were) many insurance companies out there that took the approach that only taxable term cost would be reported via the use of the rollover money. Not saying it is right or wrong, just saying...

Personally, I wouldn't do it. But then, we try not to allow insurance in our plans anyway, so these issues don't arise. Oh Happy Day!

[Bill Presson]

Hi Bill - again, without opining about correct vs. incorrect, I'll just say that there is a lot of legal talent out there that might disagree with you. And probably as much or more that agrees with you. There are (or at least were) many insurance companies out there that took the approach that only taxable term cost would be reported via the use of the rollover money. Not saying it is right or wrong, just saying...

Personally, I wouldn't do it. But then, we try not to allow insurance in our plans anyway, so these issues don't arise. Oh Happy Day!

Understood on the disagreement, especially from the insurance companies. But, at least, I have a letter from Jim Holland and they don't.

WCP