Getting Life Insurance Policy out of a Plan

[bpenfold]

I have a plan that has held a life insurance policy for only 4 participants for many years. They would like to terminate the polices, just get rid of them and take whatever the value is to themselves (they want the cash). Our record-keeper is telling us that in order to cancel the policy they HAVE to deposit the funds into the plan and then follow the plan document as far as being able to actually take the funds themselves. In this case, you have to either terminate employment or be 59 1/2 take a distribution, per their plan doc. However, we were told by the outside insurance agent that they could take the cash and be taxed on it, as normal.

I just need guidance on how to get a life insurance policy out of a plan - when the participant is under 59 1/2 and still employed?? It is possible, right??

TIA!

[MoJo]

The plan OWNS the policies.  The plan get's the cash value if the policies are terminated.

Now, if you want to get the policies out of the plan, there are two ways - 1) through an in-kind distribution ALLOWABLE under the plan (in-service, termination, or whatever is ALLOWED under the terms of the plan); or 2) the insured participants can BUY the policies from the plan - at basically the cash surrender value (which they would only do if they wanted to keep the insurance in force (as the cost of buying the policy would be exactly equal to the cash they would get upon terminating the insurance).

The record-keeper is correct.

[Bill Presson]

17 minutes ago, bpenfold said:

However, we were told by the outside insurance agent that they could take the cash and be taxed on it, as normal.

 

How can this not be accurate?  [rolls eyes so hard]

[david rigby]

24 minutes ago, MoJo said:

Now, if you want to get the policies out of the plan, there are two ways - 1) through an in-kind distribution ALLOWABLE under the plan (in-service, termination, or whatever is ALLOWED under the terms of the plan); or 2) the insured participants can BUY the policies from the plan - at basically the cash surrender value (which they would only do if they wanted to keep the insurance in force (as the cost of buying the policy would be exactly equal to the cash they would get upon terminating the insurance).

3) the participant can die.

[My 2 cents]

"They would like to terminate the policies..."

Can we all agree that if it is a pension plan, then the plan administrator of the plan,acting in a fiduciary capacity, gets to make all such decisions, and the wishes of the individual participants only carry weight to the extent that those wishes are supported by the provisions of the plan? 

The participants do not own their accounts or the assets backing their benefits, so the participants don't get to say "Just give me my money!" unless they can point to a plan provision saying that they can do that.  If the participants have the authority to direct the investment of their accounts, they can probably have the policies cashed in and those proceeds included in their account balances.

 

[bpenfold]

I have some follow-up questions:

The plan sponsor is allowing each participant to choose what they want to do with their policies. One guy wants to keep the policy and leave it as is. The three other guys (one being the plan sponsor) want to cancel their policy.

I have read some information online that lists the following ways to remove a policy from a plan:

1)TAKE A TAXABLE DISTRIBUTION, 2)PURCHASE THE POLICY, 3)EXCHANGE THE POLICY, 4)TRANSFER TO AN ILIT, OR 5)SURRENDER THE POLICY.

1. What is the difference between #1 (Taking a taxable distrib) and #5 (surrendering the policy) as far being able to do it?
2. If surrendering the policy and moving the funds to the plan - what source would those funds become? PS?
3. If surrendering the policy and moving the funds to the plan - would this be a taxable event to the participant?

[YogaTPA]

38 minutes ago, bpenfold said:

1)TAKE A TAXABLE DISTRIBUTION, 2)PURCHASE THE POLICY, 3)EXCHANGE THE POLICY, 4)TRANSFER TO AN ILIT, OR 5)SURRENDER THE POLICY.

1. What is the difference between #1 (Taking a taxable distrib) and #5 (surrendering the policy) as far being able to do it?
2. If surrendering the policy and moving the funds to the plan - what source would those funds become? PS?
3. If surrendering the policy and moving the funds to the plan - would this be a taxable event to the participant?

1) Surrender = tell the insurance company to pay the cash value to the plan. Taxable distribution = when the participant then takes the money out of the plan.

2) What type of money were the policies originally bought with? If it was PS... then yes it would be PS.

3) No... it's taxable when the money comes out. The insurance policies are already in the plan so it's not like outside money is going into the plan.

[My 2 cents]

Not a lawyer, but...

The owner of the sponsor is not acting as the sponsor.  The owner of the sponsor is a plan participant with respect to those assets held by the plan for the benefit of the owner of the sponsor.  To the extent that the owner of the sponsor is making decisions about the disposition of plan assets, the owner of the sponsor is acting as the plan administrator and is subject to fiduciary standards. This is not at all the same as the owner of the sponsor having a personal investment account that includes an insurance policy.  In this instance, the insurance policy is owned by the plan, and it is only through operation of the plan, per its provisions, that the value of the policy can be paid to the owner of the sponsor.

[MoJo]

I am a lawyer, and My2Cents nails it, especially the part of the "fiduciary standards" being applicable....

[Bird]

2 hours ago, bpenfold said:

I have some follow-up questions:

The plan sponsor is allowing each participant to choose what they want to do with their policies. One guy wants to keep the policy and leave it as is. The three other guys (one being the plan sponsor) want to cancel their policy.

I have read some information online that lists the following ways to remove a policy from a plan:

1)TAKE A TAXABLE DISTRIBUTION, 2)PURCHASE THE POLICY, 3)EXCHANGE THE POLICY, 4)TRANSFER TO AN ILIT, OR 5)SURRENDER THE POLICY.

1. What is the difference between #1 (Taking a taxable distrib) and #5 (surrendering the policy) as far being able to do it?
2. If surrendering the policy and moving the funds to the plan - what source would those funds become? PS?
3. If surrendering the policy and moving the funds to the plan - would this be a taxable event to the participant?

Forget for a moment  that these are life insurance policies and think of them as self-directed investments.  Participants (in theory) elected to purchase these investments with some of their other account money.  They can choose to move the current value back to the other investments, or they can leave it where it is.  Assuming the policies were set up properly in the first place (a fairly big assumption, given what all of us have seen screwed up by life insurance agents), then they are owned by the plan, and surrendering the policy(ies) just means moving money from one part of the plan to another.  You're not moving funds "to" the plan, you are moving funds "within" the plan.  Hence no taxable event.  In a perfect world, or just a reasonable one, the insurance policies would be tracked as "PS" or whatever kind of money they were originally bought with.  Unfortunately, some administrators choose to show premiums as "expenses" of the plan, which then leads them to ignore the values of the policies for asset reporting purposes.  Possibly the reason for some of the confusion about moving "to" or "within" the plan.

[ESOP Guy]

This just reminds me why I used to cringe when I was taking over a plan and found out there life insurance in it. It seemed like it was always a pain and done wrong. 

A side issue depending on how this whole thing was resolved there could be basis on some of this money as these people were supposed to be getting 1099-Rs each yer for their PS-52 costs.  So you don't want them to be taxed twice.  I can't remember what happens if the 1099-Rs weren't issued as I was fortunately never a part of that mistake.  You might want to look into all of this before you start actually taking actions as tax issues might be an important factor in people's decisions. 

Also, remember the purchase the policy option might be a good solution for those that want the insurance.  They need to buy the policy for FMV which is cash surrender value.  If I recall (and someone here will tell you if I recall incorrectly) the plan can take out a policy loan for 100% of the cash value of the policy.  The FMV of the policy is now $0 so it is easy to purchase the insurance.  This could come in handy if a person is now uninsurable but would like the protection of the policy. 

[shERPA]

Yes if purchased out of the plan by participants the price is FMV.  But since RP 2005-25 CSV is not automatically FMV.  IRS provided a safe harbor for FMV, the PERC amount, but other valuation methods might be appropriate.

[Pam Shoup]

When I started in this industry as an enroller (late 80s), the insurance companies were pretty much the only players in the small plan market.  401(k) plans were like the wild wild west in terms of regulation.  Insurance companies used to "strongly encourage" you to use part of the contributions to purchase life insurance.  If I recall correctly, there was a rule that said that only 25% of the expected contributions could be used to purchase life insurance.  You then had to deal with a life application and the limited underwriting that needed done with the policy, policy delivery, PS-58 costs, etc.  I guess what I am trying to say is that life insurance within a 401(k) plan has always been a pain and I am so glad no one sets them up that way anymore!

[stephen]

On 9/28/2017 at 12:23 PM, david rigby said:

3) the participant can die.

I'm guessing the participants would not prefer to be eligible to be paid their insurance benefit this way.

[Ilene Ferenczy]

One more thing that you should note when there is insurance in the plan.  There are two qualification rules that are affected when you have insurance.  First, having the insurance cannot be discriminatory.  So, i would be concerned if the insurance was only available to HCEs (which may be the case if no new insurance has been offered to anyone since 1904.  :)  Second, the amount paid for the insurance must be incidental.  If there have been years with no profit sharing contribution (assuming a profit sharing plan), it is possible that the payment of insurance premiums ceased to be incidental.  (n general, "incidental" for term policies means that the total premiums paid must be less than 25% of the total contribution and forfeiture allocations for all years; if it's a whole life policy, the percentage is 50%.  If it's universal life, it's basically the term rules, applied to the term portion of the policy.)  So, my only point here is that this is a Pandora's Box -- be sure to open it all the way or warn the client of ramifications so that it does not bite you in the proverbials.

Of course, none of this should be interpreted to be legal advice ...

Have a nice weekend, everyone.

[Bill Presson]

56 minutes ago, Ilene Ferenczy said:

One more thing that you should note when there is insurance in the plan.  There are two qualification rules that are affected when you have insurance.  First, having the insurance cannot be discriminatory.  So, i would be concerned if the insurance was only available to HCEs (which may be the case if no new insurance has been offered to anyone since 1904.  :)  Second, the amount paid for the insurance must be incidental.  If there have been years with no profit sharing contribution (assuming a profit sharing plan), it is possible that the payment of insurance premiums ceased to be incidental.  (n general, "incidental" for term policies means that the total premiums paid must be less than 25% of the total contribution and forfeiture allocations for all years; if it's a whole life policy, the percentage is 50%.  If it's universal life, it's basically the term rules, applied to the term portion of the policy.)  So, my only point here is that this is a Pandora's Box -- be sure to open it all the way or warn the client of ramifications so that it does not bite you in the proverbials.

Of course, none of this should be interpreted to be legal advice ...

Have a nice weekend, everyone.

Welcome aboard, Ms Ilene.

[ErnieG]

Great replies, the answer is quite simple.  Regarding your question and the reference to a distribution at 59 1/2 (per the Plan Document), my assumption is we are referring to a Profit Sharing Plan.  The Trustees, have control over the investments in the Plan, life insurance being such an investment.  The Plan Trustee, in my experience and to assure they are acting within their fiduciary capacity, would usually offer the participant the right of first refusal, to purchase the policy following PTE 92-6.  Should the participants decline the purchase, and the fiduciary documents such, the contracts would be surrendered.  As the Plan is the owner, the cash surrender value would be deposited to the Plan, and the pursuant to the terms and conditions of the Plan be either accessible or not to the participants.