Repayment of Loan on Insurance Policy held by Plan

[JButtrick]

We have a PS plan with insurance that pre-dates our involvement.

One of the participants dealt directly with the insurance company to take out a loan on the policy in his name and claims that the insurance company says he doesn't need to repay it.

I don't understand how he managed to get the loan without the trustees consent, but that is a question for another day.

I contend that since it is a plan asset, the loan needs to follow the same rules as any other loan i.e. have a loan agreement with the plan and be repaid in installments over 5 years.

The loan is almost 3 years old now and I have been telling the client the whole time that there need to be repayments. I contend that the loan is in default and should be taxable to the participant.

Is there any exception to the qualified plan loan rules for insurance????? This is our only PSP with insurance, so maybe there is something I'm missing.

[Bird]

My take is that this was not a plan loan at all, or I'll temper that a bit and say it may not be. Insurance, in my opinion, should be considered just another asset of the plan, with some unique characteristics. One of them is that if the plan is otherwise pooled, any insurance is effectively self-directed/segregated. That may or may not be relevant but the point is that premiums, loans or other transactions involving the insurance "account" should be considered transfers between accounts.

So you have money coming out of the insurance policy and going to a participant. The "coming out" part is a transfer out of the policy, and (to my way of thinking) you first have an effective transfer to a "side fund" (old admin terminology for everything not insurance) and then...ah, here is the question. It's either a loan, or a distribution. Of course there was no paperwork either way, and the consequences (ultimately) are the same - taxable income. How to treat it might depend on whether loans were permitted, what shred of paperwork might exist, etc. What you do have is an unfortunate mess, probably created by the agent in setting up the policy ownership correctly, and the insurance company, for being sloppy and letting it happen and then allowing the loan. None of which is surprising.

(I may be complicating the situation by creating a phantom step but I don't feel like re-typing. I guess you could boil it down to either a loan or a distribution, directly from the policy. But adding the intermediate step helps, I think, to prevent the line of thought that there could or should be direct dealings with the insurance company and participants.)

[BG5150]

What kind of loan doesn't need to be repaid?

Did the insurance company issue any sort of tax form on the withdrawal?

[ETA Consulting LLC]

The failure originated with the notion that the participant should be allowed any control of the policy. The participant is merely the insured. The plan is owner and beneficiary of the policy (I tend to use "plan" and "plan's trust" interchangeably).

So, under what authority would the insurance company act per the instructions from someone who is not the owner.

If the insurance company issued a check (from policy loan proceeds) to the participant, then that would be a taxable distribution from the plan to the participant. There is nothing (eg legally enforceable loan agreement, amortization schedule, etc.) that would invoke 72(p) to have that distribution treated as a loan.

With that said, the failures appear evident. The approach used to correct is should be interesting:-)

(I'm keying this from my smartphone, so please excuse the brevity)

Good Luck!

[JButtrick]

Thanks for the feedback. It confirms my view of the situation. Now to convince the client that it needs to be fixed.

[Bird]

What kind of loan doesn't need to be repaid?

Loans from insurance policies can go on indefinitely. An insurance loan can effectively be a withdrawal...in a non-qualified plan situation, it's no big deal.

Did the insurance company issue any sort of tax form on the withdrawal?

Ha. It's not my case but I'll say no, just based on the cloud of incompetence that I recognize from experience. I wouldn't be surprised if it's not even in the name of the plan...