Life Insurance surrender and investing CSV into other plan assets

Basics:  Individual account 401k plan with 4 insurance policies owned by the plan.  Decision has been made to surrender these policies for the cash surrender value and invest the proceeds into the individual participant's accounts in the plan.   The participant in over 59 1/2 and the plan allows for in-service at 59 1/2.  At least one of the insured plans to take an in-service after the proceeds are received and roll them to an existing IRA. 

The insurance company form indicates 10% of the proceeds will be withheld and sent to IRS.  Form also says owner can instruct insurance company to not withhold taxes.  This obviously makes it seem like insurance company is treating this as a distribution and not a "transfer" of assets inside of the plan.  So even if they are instructed to not withhold any amount for taxes it makes me think they will still create a 1099R.  1) I don't think a 1099 should be created 2) I think they will screw it up.  

Can someone confirm I am correct in thinking that the surrender and the transfer of assets into the individual account should not be a taxable event nor require a 1099?  

Based on your description, I agree with you. 
 

But how is the policy ownership listed? Was it set up correctly as the qualified plan?

What Bill said. Also, if you haven't already, check to see if the participants have been given the option to purchase the policies from the plan, rather than having them surrendered. Presumably the plan language would give them this option. 

And a class prohibited-transaction exemption sets the conditions for a purchase from the retirement plan.

https://www.federalregister.gov/documents/2002/09/03/02-22376/amendment-to-prohibited-transaction-exemption-92-6-pte-92-6-involving-the-transfer-of-individual

https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/exemptions/class/PTE77-8.pdf

Thank you all. 

13 hours ago, Bill Presson said:

Based on your description, I agree with you. 
 

But how is the policy ownership listed? Was it set up correctly as the qualified plan?

Bill - The policies are owned by the ABC Co. 401k Plan & Trust.  These policies predate me by to decades so I am going on the assumption (scary) that since the policies are owned by the plan, they were set up correctly as qualified assets.

2 hours ago, Belgarath said:

What Bill said. Also, if you haven't already, check to see if the participants have been given the option to purchase the policies from the plan, rather than having them surrendered. Presumably the plan language would give them this option. 

Belgarath - they did have that options and non wanted to purchase the policies

Now I have the pleasure of spending time (hours?) on hold with the insurance company in the hopes to find someone who will listen and understand enough to process these the right way.

2 hours ago, JohnEPNFP said:

Thank you all. 

Bill - The policies are owned by the ABC Co. 401k Plan & Trust.  These policies predate me by to decades so I am going on the assumption (scary) that since the policies are owned by the plan, they were set up correctly as qualified assets.

Belgarath - they did have that options and non wanted to purchase the policies

 

Now I have the pleasure of spending time (hours?) on hold with the insurance company in the hopes to find someone who will listen and understand enough to process these the right way.

 

Best of luck. Couple of suggestions: 1. Do you have any information on a servicing agent or office? Might be best to try them first and have them link you to the right person at the company home office. 2. If you have to call the home office blind, ask for the advanced planning or qualified plan department. They probably aren't the ones issuing 1099s, but someone there is more likely to understand your dilemma. They might be able to pull a string or two.

...and you probably know that you probably need an authorization; sometimes you can fax it to them while on the line, or else have the trustee/owner on the line as well. No fun at all, except to the extent that you get satisfaction in doing things right and doing other folks' jobs.