Life Insurance question

[Guest VAP]

We currently have a profit sharing plan that has one life insurance policy we have just recently found out about. The policy has been in the plan since 1995, but has never been reported as an asset because we were never informed of its existance. The premiums for these years have been paid directly by the company.

We are currently in the process of removing the policy from the plan and transferring the ownership directly to the insured. Because of the size of the policy, it has been suggested that a policy loan be made equal to the cash value as of 9/1/95 (begining of plan). That money would then be invested in the insured's profit sharing plan account. The ownership of the policy would be transferred to the insured and he would then enter into a Split Dollar agreement with the corporation and continue to have the corporation pay the premiums.

Questions:

1.) Is this a possible scenario?

2.) What are the tax consequences for the insured?

[Bill Berke]

There are a number of issues and it sounds like the insurance agent is making the suggestions (sorry for the sarcasm if you sold the policy).

1. If there are other participants you have a 410(a)(4) problem with which the employer can deal with or ignore (at some minor? risk of audit lottery). And you could also have a 404 deduction problem depending upon the sum of the premium (each year) and the employer's contribution (each year.

2. You cannot retroactively date take a loan from this policy. How on earth could you do this? Suddenly you find a loan that was never recorded on the insurance companies books - as requried by insurance law and the terms of the policy - read the contract. You could take a maximum current cash value loan to help the insured purchase the policy from the plan. If the loan is for less than 100% of the current cash value, then the insured would have to pay the difference into the plan. At least this gets the policy out of the plan for relatively little cash. At all times the plan must be made whole, which means buying the policy for its current cash value. And be careful if you are near a policy anniversary date. There is a formal procedure for doing this. Note: If this a one person owner only plan then 401(a)(4) is a non-issue and you don't have to worry about how close the policy's anniversary is.

3. Considering the policy is more than 4 years old, if the cash value loan is limited only to the amount accumulated AFTER the fourth year, then the 4 out 7 rule could apply and the insured may be able to take advantage of that rule. But, I believe the consumer loan rules kills this deduction - I'm not sure

4. Once the policy is owned by the insured then he/she could split dollar future premiums under the IRS rules. But, the IRS just came out with new split dollar rules which, as I've heard, effectively stops the tax arrangements.

5. What is so valuable about the policy? Assuming the insurance agent didn't know the basic federal law non-discrim rules regarding plan policies he/she sold, why would you think the agent knows how to do split-dollar correctly?

6. There are special and ugly income tax rules if an insured dies while a policy loan is outstanding. This is somehow overlooked by most insurance agents when describing the "wonderful" advantages of borrowing from a policy.

7. It is unlikely that any tax advantaged (deductible) scheme would apply regarding the future premiums.

8. Be careful if the agent suggests transfering the policy all over the place. There are special income tax rules limiting who/what can be the recipient of a transferred policy - called the transfer for value rules.