Life insurance in a Cash Balance Plan

I am the TPA for a client with an over-funded cash balance plan.  Husband and wife participants. Both age 42.  His investment advisor is recommending that the plan purchase a life insurance policy.  I recall a time when life insurance was a popular choice in DB plans but primarily to fund contributions.  I no longer have any plans that contain a life insurance product and prefer to keep it that way.  His plan will need to be amended to permit this. Since I am not current on the rules, I would love to hear from some of you experts who can give me an opinion on whether it makes sense to purchase one from an over-funded CB plan?   

Putting insurance in a pension plan is usually a great idea if you are the agent making the sale.  Your client should talk to their accountant and/or financial advisor (not the one selling him/her the insurance) and determine if it makes sense from a long term financial perspective.  It might be a great idea, but more likely a its a horrible idea.   

Exactly!  Whenever I see the phrases "husband and wife" and "cash balance" and "overfunded", I wonder if the last one is true.  Has there been a real 415 test? 

A consulting actuary would ask lots of questions, which might include: Why is a husband/wife plan structured as cash balance rather than traditional DB?  Do the participant(s) have health status that impairs insurability?  What is the magnitude of any "overfunding"?  What are the ages of the participants?  How soon do the participants plan to retire/cease working?  Are there others (e.g., children) that might join the business?  Do the participants plan to choose a lump sum distribution (at some later date) or choose a J&S payment form?  Does the business also have a DC plan?  A really good consulting actuary will explain to the plan sponsor how these questions are inter-related.

10 hours ago, david rigby said:

Exactly!  Whenever I see the phrases "husband and wife" and "cash balance" and "overfunded", I wonder if the last one is true.  Has there been a real 415 test? 

A consulting actuary would ask lots of questions, which might include: Why is a husband/wife plan structured as cash balance rather than traditional DB?  Do the participant(s) have health status that impairs insurability?  What is the magnitude of any "overfunding"?  What are the ages of the participants?  How soon do the participants plan to retire/cease working?  Are there others (e.g., children) that might join the business?  Do the participants plan  to choose a lump sum distribution (at some later date) or choose a J&S payment form?  Does the business also have a DC plan?  A really good consulting actuary will explain to the plan sponsor how these questions are inter-related.

It is very easy to do something, but “undoing” is where the problems begin.

So I am adding the following to the list:
How easy will it be to obtain the annual market value of the insurance policy for actuarial valuation purposes?
When the Cash Balance Plan is terminated, what will happen to this life insurance policy? (No — a typical “free” IRA will not be able to hold it.)
Will the current actuary be willing to perform services for a plan that includes life insurance, or will you be required to find another actuary?

truphao, the life insurance carrier will provide both the Fair Market Valuation and the annual Economic Benefit Report.  If the carrier is versed in using life insurance in a Qualified Plan both reports are generated and sent to the Plan Sponsor annually.  Upon separation from service the life insurance generally can be surrendered, distributed, or purchased.

Does the proposed insurance serve a purpose other than a sop of account value?

Yes provides an income tax free death benefit (face amount minus cash value assuming the participant reported and paid tax on the annual economic benefit).  This assumes there is a life insurance need.  Using permanent whole life insurance provides guarantees for the fixed return portion of the portfolio.

Thank you all for your responses.  I agree with Effen that the person who thinks it's a great idea is the person selling the policy!  I am under the impression the policy will be used as a tool to absorb the assets.  The plan is to surrender the policy in about 5 years (not sure why that number).  The participants are relatively young at age 42 and current excess is around $500,000.  The owner is a physician.  They also have a 401k/PS plan.  This was a takeover plan that we are trying to get cleaned up.  I will discuss with my actuary to determine the best course of action.  Thank you again for taking the time to give me your thoughts.

"the policy will be used as a tool to absorb the assets".  Always been my opinion that assets are a good thing.  If you absorb them, then where did they go? Who are you giving them to?  Why would someone want their assets "absorbed"?  Even if they are taxable they are still useful. 

If they are only 42, they have many years before they will collect their pension dollars.  Consider the impact of taking less risk with the pension assets, and maximizing their equity risk on the personal assets.  IOW, don't look at the pension plan independently, but consider it the fixed income allocation of the entire entity.  

They should consult with a financial advisor.

20 hours ago, ErnieG said:

truphao, the life insurance carrier will provide both the Fair Market Valuation and the annual Economic Benefit Report.  If the carrier is versed in using life insurance in a Qualified Plan both reports are generated and sent to the Plan Sponsor annually.  Upon separation from service the life insurance generally can be surrendered, distributed, or purchased.

Surrendered = loss of money

Distributed = taxable event or expensive custom IRA (or 401k/PS) able to hold it

Purchased = the Owner has to come up with cash

truphao:  There is a bias against using life insurance however done correctly with professionals versed in such usage works well.  I'm not clear on the "loss of money" considering some contract used in this market have high first year cash values (95% of premium), and as I had outlined earlier, there must be a need for life insurance protection (just a question of how are you paying for it).  The life insurance may not be transferred to an IRA, and yes to purchase they individual would have to come up with the fair market value, but some strategies would be to take a loan on the policy to reduce the fair market value to a point that is workable for the individual.  Also those professionals in using such strategies with life insurance plan for the distribution before the sale is made so the client is prepared for the exit strategy.

As usual, @Effen states the issue better than I.  For participants in their early 40s, I suggest there is a potential future surplus but NO current surplus, since many things could happen in the next 2 decades to affect the plan's funded status.  If you want a discussion of these many things, I'll be glad to recommend an experienced consulting actuary, since the list of such items is very long, 

Overspending on life insurance now will benefit only the person receiving the commission.  It would be more prudent to evaluate any surplus closer to actual retirement rather than assuming it must be "absorbed" now.