Tax Cowboy Posted October 19, 2021 Posted October 19, 2021 Group: PC and wife (66/70 yrs) has $20mm in IRA's. Already used lifetime gifting on other highly appreciated assets with a FLP many years ago. I'm told these assets are outside of his FLP. He has said one strategy he's looking at has the following steps: 1. Set up qualified Def Contribution (DC) plan. 2. Rollover $20mm tax-free from IRA into DC. 3. Use funds to purchase High Cash Value insurance at $2.5mm per year premium for 4 years. Per spouse. 4. After yr 4, sell insurance policies to his FLP. 5. PC is relying on DOL PTE 92-6. My reading of advisory opinion is the DOL essentially allows sale of insurance policy out of insured's qualified plan. 6. PTE 92-6 seems to say that the fair market value to purchase the insurance policy is its cash surrender value. Which is far less than the tax if PC were to distribute all IRA funds. I'm beginning to review for pitfalls/risks and asking the collective wisdom of the group if they have researched this transaction. Q: My initial thought is that a traditional defined contribution plan has a limit of 51% insurance and max of 49% annuities. Is this correct? Therefore, in the above facts, it's doubtful a majority of funds can be used to purchase life insurance. Q: I recall the issue the IRS had with welfare plans in 2000's was the springing cash value in future years? Even if purchase the insurance policy after yr 4 this transaction seems to have similar issues. Or at least the potential issue for the govt to raise in tax court. I believe IRC 269 is the govt catchall fraud argument for any abusive transaction. Thoughts and comments appreciated.
shERPA Posted October 19, 2021 Posted October 19, 2021 FMV ≠ CSV. See Rev Proc 2005-25. Luke Bailey 1 I carry stuff uphill for others who get all the glory.
ErnieG Posted October 20, 2021 Posted October 20, 2021 We frequently use life insurance in both Profit Sharing and Defined Benefit Plans (when there is a need for survivor benefits). However, I have also frequently encountered the scenario you are outlining. While the strategy fits all the legal requirements if you are abiding by the PTE and the Rev. Proc. it generally lacks economic sense. First, I am assuming there is a valid business entity, second there will be “recurring and substantial” contributions to the plan; third and last, why? The premium is before tax, but the FLP will have to purchase the policy at its FMV as shERPA stated or be distributed with tax due at the FMV. With high cash value policies, the cash value, more than likely, will equal the FMV. Where is the leverage? Assume in 4 years $20 million has been paid in premiums $2.5 x 2 x 4) and there is $19 million in cash value (my experience has been with some carriers’ high cash value contracts the cash value is generally 95% of the premiums paid. Some questions: Is the exit strategy for the policies documented? Does the FLP have the cash to purchase the policies to avoid the tax? Can the FLP pay the tax? If the participants die within the 4 years while the policies are in the plan the beneficiaries will only receive a portion of the death benefit income tax free (the face amount minus the cash value) as opposed to the enitre face amount. Are they prepared to pay the economic benefit each year (also known as the PS 58 or Table 2001 rate or the carriers one year term rate if it is available and regularly sold to the public)? Is there additional cost of administration (TPA fees)? Is the client's other professional advisors (tax and/or legal) on board with this strategy? What happens after 4 years to the policies, who is paying the premiums? Would it be more efficient to spread the premium payments out, more than 4 years, and have IRA distributions pay the premiums? ugueth 1
Tax Cowboy Posted October 22, 2021 Author Posted October 22, 2021 Thank you for the responses! very helpful. I was only able to find a few US Tax Court cases discussing a somewhat similar issue post 2005. ErnieG hit one of the issues on the head. That the cash value at end of yr 4 may be relatively high. I believe the PC has been informed that - due to internal insurance costs - the cash value by end of yr 4 will still be relatively low. If that's the case, this smells like a springing cash value. The other potential risk I thought about since posting this query: What happens if (and when) the IRS tax promoter division (or whatever their new name is this year) comes knocking? There's a lot of risks here with what I'm told by PC so I'm most likely going to bow out of working with PC and the advisor who wanted to bring me in. Thank you!
Recommended Posts
Create an account or sign in to comment
You need to be a member in order to leave a comment
Create an account
Sign up for a new account in our community. It's easy!
Register a new accountSign in
Already have an account? Sign in here.
Sign In Now