A qualified retirement plan may purchase life insurance to provide death benefits. Such a purchase must be authorized by the plan document but the decision to buy a policy may be made by either the plan administrator (employer) or the participant. In a Defined Contribution plan, the policy is part of the participant’s account. In a Defined Benefit plan, the death benefit is part of the definitely determinable benefit provided to the participant by the plan.
The purchase of life insurance must be incidental to the primary purpose of providing retirement benefits under the plan. Under treasury regulations, this incidental benefit results in limits being placed on the amount of premiums paid as follows:
Contributions that have been in the plan for two years or more may also be used to pay life insurance premiums. After-tax employee contributions and rollover contributions may be used to pay premiums and are not subject to the incidental rules.
Defined Benefit Pension plans usually use the 100x rule, which says insurance benefits are considered incidental if the face value is no more than 100 times the anticipated monthly annuity benefit provided by the plan. Because of this, most or all of the participants in the plan must have insurance policies.
The life insurance protection portion of the premium must be taken as a taxable benefit annually by the insured plan participant. This is called a P.S. 58 cost. The IRS has a table (Table 2001) outlining the determination of the insurance protection amount at a particular age. The formula is as follows: Face amount less cash value divided by $1,000 times the table factor. The insurer’s published rates may be used instead, but caution should be taken for policies issued after 2003. The P.S. 58 costs are basis in the participant’s account and are not taxed again when distributed to the participant or beneficiary unless the participant is a Self-Employed Individual.
Death benefits payable under the life insurance policy are considered “net proceeds” and excluded from gross income. Net insurance proceeds are calculated by taking the face amount of the policy less the cash value plus the accumulated P.S. 58 costs. For example, a policy with a $300,000 death benefit, $60,000 in cash value and $10,000 in accumulated P.S. 58 would result in a tax-free benefit of $250,000 to the beneficiary.
Death benefits are paid to the plan trustee and distributed to the beneficiary as part of the participant’s total benefit.
There are several options for a participant who separates from service with a life insurance policy held by the plan.
Allowing for life insurance to be purchased within a qualified retirement plan may be valuable in certain circumstances. Offering this benefit within the plan requires additional administration by a company that understands the nature of the products. At Benefit Resources, Inc. we have significant experience working with insurance in qualified plans and we take the necessary steps to guide our clients who choose this option. We report the cash value on the participant statements. We compute, track and report P.S. 58 costs, and we offer options at termination or retirement for the disposition of the policy.
At Benefit Resources Inc, we love what we do and it shows. We build trusted relationships with our clients by creating added value and ensuring a smooth process.
Beth Harrington is the Founder of Benefit Resources, Inc. She started with a vision, and a passion for Retirement plans. Thirty two years, and over four hundred clients later, she is still growing and going strong, helping the people of the Sacramento and the surrounding areas retire with confidence.
