Purchase of paid up whole life insurance with an account balance?

[Guest]

An insurance agent of a client of mine proposes using approximately $400,000 of an $800,000 account balance in a frozen plan to purchase a paid up whole life first to die policy on the lives of the participant and his spouse. No insurance has been purchased in the past, so the $400,000 is available. I believe (but am not sure) that the goal is to take a distribution of the policy in about five years when the cash value is still low, apparently to avoid taxes. Does this seem reasonable? Can the policy be a first to die, thus insuring the life of a nonparticipant (the participant's spouse)? Thanks.

[david rigby]

Purchasing a paid-up whole life policy?! Wow!

Where is the advantage to the IRA owner? This looks like the goal is to generate a large commission.

[KIP KRAUS]

I think pax hit the nail on the head. Commissions are about 20% to 30% on the premiums. Would be a nice Christmas present for the agent.

[Michael Devault]

You might want to review IRS Notice 89-25, Q&A 10. The cash surrender value is generally the fair market value EXCEPT in cases where the policy reserves "...represent a much more accurate approximation of the fair market value of the policy than does the policy's stated cash surrender value." In other word, distribution of the policy when the cash value is low may not avoid income taxes.

[R. Butler]

I agree with the previous posts, the insurance agent may have alterior motives. To answer your second question, second-to-die policies covering the participant and the participant's spouse are permissable.

[Kirk Maldonado]

Although I am admittedly not a proponent of the investment of qualified plan assets in life insurance, I reviewed an arrangement strikingly similar to those facts, and surprisingly concluded that it made sense. This review involved the extensive use of an estate planner and a vast amount of computations that the two of us prepared.

Both myself and the estate planner were extremely skeptical that it made sense, but our own computations provided our initial presumptions to be incorrect.

However, that was the only case that I've ever seen that made economic sense. It also involved a very young person with an obscenely high cash salary (the highest I've ever heard of) and a truly massive personal estate.

[Guest]

I too have been involved in this type of transaction in the past. it was generally utilized to limit exposure to: 1. excess accumulations tax on the distribution, and 2. to as an estate planning tool to lessen the impact on estate taxes.

I agree also, that it may make better sense to structure using a second to die policy, but again this is an estate planning issue.

P.S. In the situation I was involved in, the participant had an account balance of 12 million dollars and was looking to reduce the excess accumulations tax. He was more than willng to pay a commission to the agent since the commission was less than the excess tax.

[Kirk Maldonado]

My scenario also involved the excess contributions tax. However, after the repeal of that tax, we reran the numbers, and the arrangement still made economic sense, although it was a much closer call afterwards.

[Guest Matt Tuttle]

We do these from time to time as an estate planning move but again using 2nd to die---I don't understand what first to die gets you here. The key is to get the insurance out of the plan and into an irrevocable life insurance trust on the first death so that the death benefit will not be in the estate. If the participant dies first this is easy, if the spouse dies first it is not so make sure that your insurance agent understands the complexities.

This strategy only makes sense where the client was going to do an irrevocable life insurance trust---here you are using pretax dollars that they aren't going to touch until age 59 1/2, you are not paying gift taxes, and if they change their mind or the estate tax is repealed they can surrender the policy.

Matt Tuttle

203-609-9077

http://www.wealthadvisors.bigstep.com