Insurance contract payment made to Trustee

[BG5150]

Question: A participant of a company dies, and their life insurance premiums have been paid by employer contributions. The life insurance company can only make the check out to "The Trustee of the ABC Company 401K." Can the employer deposit the check to trust at the record keeper  and, from there, allocate the funds to the deceased participant account? 

Or how else does this get done?  I have very little experience with life insurance contracts in 401(k) plans, and this might be the first time I've ever had one pay out.

[Peter Gulia]

It’s not unusual for a life insurer to say its obligation ends with paying the death proceeds to its contract’s beneficiary.

A retirement plan’s trustee, the trustee’s custodian, or either’s agent would receive the insurer’s payment, and the recordkeeper would (following the plan administrator’s express or implied instruction) credit an amount according to the retirement plan’s provisions.

For an individual-account retirement plan, that’s typically crediting the amount to the deceased participant’s account.

From there, a plan’s administrator would evaluate each claim that the claimant is the participant’s beneficiary according to the plan’s claims procedure.

If no claim is submitted before the § 401(a)(9) beginning date nears, the plan’s administrator might initiate its finding about who is the participant’s beneficiary and prepare to pay an involuntary distribution.

This is not advice to anyone.

[ErnieG]

BG5150:  In addition to the check the Plan Administrator will also need to determine the tax-free death benefit and the taxable portion from that check, provided this was paid from the participant's account and they were reporting the economic benefit (PS58 costs).  The Insurer can easily calculate this on the date of death.

[Peter Gulia]

BG5150, the plan’s administrator ought to heed carefully a duty about tax-information reporting, and (often) a need to count excludable and taxable portions of the plan’s distribution.

A life insurer might have or might lack information to support a reckoning of the death-benefit portion, the surrender-value portion, and previously-taxed amounts.

Even when an insurer has all needed information, an insurer might have little or no duty or obligation regarding the retirement plan’s tax-information reporting of the plan’s distribution.

The Treasury’s rule about the Federal income tax treatment of “Life insurance contracts purchased under qualified employee plans” is 26 C.F.R. § 1.72-16 https://www.ecfr.gov/current/title-26/section-1.72-16.

This is not advice to anyone.

[acm_acm]

Seems like the plan being the beneficiary means the payment to the participant will be taxable, no?

[Peter Gulia]

A tax-qualified retirement plan might provide the plan’s payer’s tax-information reporting treating the plan’s participant as having been the beneficial owner of the life insurance death benefit (if the “P.S. 58” or other measure of each year’s value of death-benefit protection was tax-reported to the participant).

This is not advice to anyone.

[ErnieG]

acm_acm:  As Peter captioned if the economic benefit has been reported by the insured then the "net death benefit" passes income tax free to the beneficiary.  The "net death benefit" is the face amount minus the cash value.  The cash value and other assets may be transferred to an IRA.  There is basis to the beneficiary that may be recouped.  It is important that these details be explained and working closely with the client's tax or legal advisor.