Life Insurance Plans in 401(k)

[401(k) DUDE]

Hello All,

I am trying to find out the tax consequences of moving a life insurance plan out of the name of the 401(k) plan when a participant terminates. Is this treated like a distribution?

[Belgarath]

Default answer - yes. But it depends upon how it is done.

1. If policy is simply assigned to the individual, the "Fair Market Value" (FMV) is taxable, minus accumulated Taxable Term Costs for common law employees (but not for sole props or unincorporated partners). FMV is often the same as "Cash Surrender Value" but not necessarily the same. Depends on the ins. co. and the policy.

2. If participant PURCHASES the policy from the plan for FMV, no taxable event. This is the best option if the participant can afford to do it, and wants/needs to keep the policy in force.

3. Getting more into the weeds, the Plan Trustee can first take a loan against the policy to essentially "strip" out the cash value, THEN assign it. This will reduce or eliminate any taxable distribution, BUT, the former participant will now have a policy with a loan against it, which may not be desirable or appropriate, depending upon a lot of factors.

The answers to your situation are not simple, depending upon facts and circumstances, so some careful analysis may be needed. If the insurance agent is good, agent can actually help you with this. If not, then you'll need to seek other advice.