Life insurance policy distribution

[Santo Gold]

I realize that the answer to this question is "in the plan document", but I've read it and still am unsure how to proceed.  Any basic guidance on this is appreciated.

A 1 life plan has life insurance in it as well as other investments.  The owner is getting close to retiring.  He would like to terminate the plan but maintain the policy outside of the plan.  In this case, is it common for him to pay the cash surrender value of the policy into the plan and then have the policy moved out of the plan and retitled as a personal life insurance policy, which would avoid any taxation on the policy at the time of the transfer?  Is there any other way for him to continue the policy outside the plan, not pay the CSV into the plan and not be taxed on the CSV at the time of transfer?

If he just took ownership of the policy and did not pay the CSV to the plan, he would be taxed on the CSV of the policy at the time of transfer, is that correct?

FWIW, its the insurance guy who sold him the policy that is asking this questions :)!!!

Thank you

 

[Bill Presson]

The transaction you described is basically what needs to happen. What I would recommend is that the insurance guy contact his home office’s advanced consulting office and get the exact instructions on what to do. 
 

If he refuses, tell the client to hire an ERISA attorney. 

Lots of possible liability sitting here. 
 

wcp

 

[Peter Gulia]

A prohibited-transaction exemption (which is available regarding both ERISA §§ 406-408 and Internal Revenue Code § 4975) sets a playbook for a plan’s sale of its life insurance contract to the participant/insured.

Prohibited Transaction Exemption 92-6 (PTE 92-6) Involving the Transfer of Individual Life Insurance Contracts and Annuities from Employee Benefit Plans to Plan Participants, Certain Beneficiaries of Plan Participants, Personal Trusts, Employers and Other Employee Benefit Plans

amended, 67 Federal Register 56313 (Sept. 3, 2002)

https://www.govinfo.gov/content/pkg/FR-2002-09-03/pdf/02-22376.pdf

Here’s the key condition: “the amount received by the plan as consideration for the sale is at least equal to the amount necessary to put the plan in the same cash position as it would have been had it retained the contract, surrendered it, and made any distribution owing to the participant on his vested interest under the plan[.]”

Or, if the plan provides (or at least does not preclude) a distribution of property other than money and the insured participant is entitled (perhaps by having reached a specified age) to a distribution, the participant might claim his distribution. The plan’s trustee would tax-report the distribution on Form 1099-R.

[SRM]

Also see rev. Proc. 2005-25 which defines fair market value of the policy for this purpose.  It may be more than the cash surrender value.

[Peter Gulia]

Fair market value might matter.

A loyal, prudent, and impartial fiduciary might not sell a retirement plan’s contract for less than adequate consideration, which might be the contract’s fair market value.

Or if the plan distributes the contract to the participant, fair market value might affect the amount the plan trustee tax-reports on Form 1099-R.

Showing attention to the valuation methods described in the Internal Revenue Service’s guidance might help show that the plan trustee acted in good faith.

[Bird]

A common tactic for getting a policy out of a plan without a big buyout or tax consequences is to have the plan borrow from the policy, thereby reducing the net CSV (FMV to be precise as noted above). Then you have a stripped-down policy with little or no value which can be bought or distributed more easily.

Now the policyholder will own the policy, but will have to pay more outside the plan in interest to keep it going. And the cash value will be reduced because of the borrowing. 

[Paul I]

The policy can be distributed to the participant.  The value of policy can be determined by using one of the methods available as defined in Rev. Proc. 2005-25.  (They are a little complicated to go into detail here, but the insurance company that issued the policy likely can do the calculation.)

For purposes of determining the taxable value of the policy distribution, 1.72-16(b)(4) does not permit owner-employees to exclude an basis attributable to PS 58 costs previously taxes while the policy was held within the plan.

[Jakyasar]

I think the term describing the actual CV to be distributed is interpolated terminal reserve (if my memory serves me right) and yes it has to be done under RP 2005-25 - written to avoid springing cash values, ahhh the good old days.

Remember that, it is a distribution and subject to whateevr the plan states like spousal consent, any QJSA requirements etc etc etc.

Assuming that this is a DC plan, right? If a DB, far more complicated.

[Santo Gold]

Wow, thank you all for that information.   It is a D profit sharing plan, not a DB.

[Jakyasar]

Great, faaaar less complicated. Just watch for the document's distribution provisions e.g. in service and things like that.

[Roycal]

A footnote. If a plan does not provide for something that is legal, that is, would not disqualify the plan or result in a PT, remember that you may always amend the plan to fix whatever needs to be fixed before a distribution (or plan termination).  Make the amendment first; do not try it "retroactively."