Insurance Premiums Paid Outside of Plan

I'm taking over a client where there are two life insurance policies owned as Plan assets.  Here is the issue, the premiums were paid outside of Plan assets.  Normally we would use those payments as part of the contributions for the year, but the issue is that the premiums are actually in excess of the allowed contribution (plus the client also made an additional contribution in '22 for the '21 plan year).

Would there be an issue in having the fund reimburse the owners who made the premium payments from outside the Plan?  That way the premiums were paid by the Plan and the additional contribution could be made?

I just wanted to make sure that this wouldn't create additional issues.

Thanks in advance!

9 minutes ago, metsfan026 said:

Would there be an issue in having the fund reimburse the owners who made the premium payments from outside the Plan?

Yes. The insurance policies are plan assets and the premium payments are contributions. Reimbursing them from anywhere is not ok.

1 minute ago, Bird said:

Yes. The insurance policies are plan assets and the premium payments are contributions. Reimbursing them from anywhere is not ok.

The problem is that the premiums weren't paid from within the Plan.  The Plan isn't allowed to reimburse them and then make additional contributions?

Any suggestions on how we solve the issue where premiums paid are in excess of the allowed Profit Sharing contributions for the year?

3 hours ago, metsfan026 said:

The problem is that the premiums weren't paid from within the Plan.  The Plan isn't allowed to reimburse them and then make additional contributions?

Any suggestions on how we solve the issue where premiums paid are in excess of the allowed Profit Sharing contributions for the year?

You have a 415 excess or a 404 nondeductible suspense account issue.

It seems there is an "incidental benefit" violation if the premiums are exceeding the incidental benefit limit.  This could potentially disqualify the Plan if not corrected.  I would look to correct under SCP depending on the specifics or the IRS' new pilot correction program by having an ERISA attorney handle the details.  We have caught these failures proactively and remedied by reducing the premium thus reducing face amounts, distributions or purchases of the policies, or surrender.

22 hours ago, metsfan026 said:

The problem is that the premiums weren't paid from within the Plan.  The Plan isn't allowed to reimburse them and then make additional contributions?

Your situation is no different from simply contributing too much to the "side fund" (if you are old) or the regular investment account.

15 hours ago, ErnieG said:

It seems there is an "incidental benefit" violation if the premiums are exceeding the incidental benefit limit.

That is indeed a possibility, but (highly) unlikely in my experience. 

As Bird is alluding (I think) -

Why not just liquidate the participant's "regular investment account" for the difference?  That way, most of the premium ends up paid by the company's deposit (deemed a contribution), and the difference shows as a "transfer" from the mutual funds or whatever, into the policy value.  A premium of 10,000 might be "covered" by the normal annual allocation of 9,000 and then you offset his other investments by the remaining 1,000.

Meanwhile that 1,000 then goes toward funding everyone else's normal share of the allocation that got our guy 9,000 in the first place.

Some accounting manipulation, but this way, the guy's actual annual additions are as intended, and the premiums count towards the plan's overall total amount to allocate.

Bird:  I could be misreading the original concern, "...but the issue is that the premiums are actually in excess of the allowed contribution..."  If premiums are in excess having the premiums paid from the current investment account would still have the issue of excess premium payment.  The incidental rule, as you know, are aggregated, not year by year.

On 8/11/2022 at 9:33 AM, ErnieG said:

The incidental rule, as you know, are aggregated, not year by year.

Exactly. How likely is it that this (the incidental benefit rule) is a problem if they exceed 415 (for what I believe to be one year)?

Bird:  Compliance with the incidental benefit rule is a qualification issue.  It should not be an issue if properly corrected for that year.  

1 hour ago, ErnieG said:

Bird:  Compliance with the incidental benefit rule is a qualification issue.  It should not be an issue if properly corrected for that year.  

Sure. But I've said multiple times and multiple ways that it is unlikely to be a problem. Assuming they are whole life policies, the CUMULATIVE limit is 50% of contributions. Maybe I'm making an unwarranted assumption, but I get the idea this is a one year bump, and it seems unlikely to put them over 50% of cumulative contributions. If they've been doing this for years, then yeah...

On 8/10/2022 at 9:55 AM, Bird said:

Yes. The insurance policies are plan assets and the premium payments are contributions. Reimbursing them from anywhere is not ok.

Understood, so what is the fix since the premiums were paid outside of the plan.  With the Cash Balance Plan also in place, the premiums are greater than the 6%.  What's the way to correct the issue?

19 hours ago, metsfan026 said:

Understood, so what is the fix since the premiums were paid outside of the plan.  With the Cash Balance Plan also in place, the premiums are greater than the 6%.  What's the way to correct the issue?

It would have been helpful to know that there was a cash balance plan and the problem is the 6% limit (!).

As I suspected, the incidental benefit commentary was an unfortunate distraction from the real issue. You have contributions that are not deductible. The first thing you do is take charge and tell them not to do this again - figure out how to pay the premiums from plan assets, not from the company. Then you have to figure out how much is nondeductible - I think it is not as simple as just the excess over 6%; I'll let others opine on that. They can deduct the excess in future years.

One point on the premiums being paid from the business and not the plan.  The business can pay the premiums however the TPA must be aware of such in order to properly perform the incidental benefit test on the entire contributions for the year and past years.

3 hours ago, Bird said:

It would have been helpful to know that there was a cash balance plan and the problem is the 6% limit (!).

As I suspected, the incidental benefit commentary was an unfortunate distraction from the real issue. You have contributions that are not deductible. The first thing you do is take charge and tell them not to do this again - figure out how to pay the premiums from plan assets, not from the company. Then you have to figure out how much is nondeductible - I think it is not as simple as just the excess over 6%; I'll let others opine on that. They can deduct the excess in future years.

I've already instructed them that moving forward all payments have to be made from Plan Assets.  The issue I'm running into is for '21, where they paid the premiums outside of the Plan. 

Is it possible to chalk it up to an administrative error and have the Plan reimburse for these payments (and carry them as a liability for one year)?  That way there is no deduction taken for the payments and it's as if the Plan had paid them?  That's what would be simplest, if it's allowed.

On 9/9/2022 at 12:48 PM, metsfan026 said:

I've already instructed them that moving forward all payments have to be made from Plan Assets.  The issue I'm running into is for '21, where they paid the premiums outside of the Plan. 

Is it possible to chalk it up to an administrative error and have the Plan reimburse for these payments (and carry them as a liability for one year)?  That way there is no deduction taken for the payments and it's as if the Plan had paid them?  That's what would be simplest, if it's allowed.

Of course we would all rather be able to do that, but no it's not allowed. If you want to take your chances, that's up to you.