Maintaining Life Insurance for Terminated Participants

I'm struggling to figure out if a defined contribution plan can maintain a life insurance policies for terminated participants.  The EOB basically reiterates what's in Revenue Rulings 54-51 and 57-213, which essentially says a plan may not maintain "ordinary life insurance" {read "whole life"} after a participant "retires".  I'm not sure what "retires" means in this context.

The IRS preapproved document we use includes the standard IRS language, which is as follows:

BPD Section 10.08(d) says, “Life insurance policies under the Plan, which are held on behalf of a Participant, must be distributed to the Participant or converted to cash upon the later of the Participant’s Annuity Starting Date (as defined in Section 1.12) or termination of employment.”

And then Section 1.12 says in part, “Annuity Starting Date. The date an Employee commences distribution from the Plan. If a Participant commences distribution with respect to a portion of his/her Account Balance, a separate Annuity Starting Date applies to any subsequent distribution. If distribution is made in the form of an annuity, the Annuity Starting Date is the first day of the first period for which annuity payments are made.”

Any insights would be greatly appreciated!

The ASD is essentially when the participant gets money out of the plan. So you can maintain life policies for terminated participants as long as they don't take their money out (as a lump sum or an annuity). With that said, the policies still have to meet the incidental rules to avoid having the full premium be considered a taxable distribution. For a terminated participant, that's difficult because there are no new contributions.

You'll also see in 10.08(a)(4) and (5) some exceptions to that incidental rule. I'm always fascinated with the language in the documents that say "in these circumstances, you can just ignore the incidental rules" because they never clarify why you can do so. It's because when you don't satisfy the incidental rules, the entire premium you pay is an in-service taxable distribution.

Thanks Bill. That is helpful.

Most of our plans do not offer an annuity option, but would a participant reaching their RBD trigger the requirement to distribute or surrender a life insurance policy held on their behalf assuming the participant only takes annual required minimum distributions?

And then maybe this is too far in the weeds, but I would think that if the participant requestes that the policy be put on "reduced paid up" status (no premiums due), the policy could stay in the plan without violating the incidental death benefit rule given the original premiums that funded the policy theoretically would not have violated the incidental death benefit rule?

Perhaps. I've never had anyone look to do that, so I haven't researched it. But if someone really wants to keep the life insurance in place till they die, they need to get it out of the plan. And that ideally would happen 4-6 years after it first went in the plan. After that, it's a costly exercise.