Buying life insurance with pre-tax funds
I have a retired client who received a proposal to take his IRA money roll it to a Keogh (starts a consulting firm) then buys split dollar life insurance where the proceeds are tax free upon death, except for estate taxes.
Is anyone there familiar with this concept?
Permalink Submitted by mk foss on Mon, 2010-05-24 16:38
This sounds like a variation on a program that was out a while ago. The previous version had the qualified plan (Keogh) purchase life insurance on the owner for a large sum – then a year or two later, the owner could buy the policy from the plan or the policy would be distributed as a retirement distribution. The key was that the life insurance policy was worth less than the premium dollars expended. The IRS came out with some pronouncements that took the benefits away – mainly by specifiying how the life insurance would be valued in this situation.
I’m not sure what theory makes this one work, but I’d be leery.
Permalink Submitted by BruceM on Fri, 2010-05-28 04:54
My first question is why ‘split dollar’? Who is the premium being ‘split’ with? Split dollar is usually used in SERPs or as an outright benefit to executives….never heard of it in a retirement plan, as the contributions to the plan would pay the premium….not a loan from the employer.
Under the ‘incidental benefits rule’, LI may be held in a QRP. But I would tread carefully here.
There is a question of whether the IRA rollover would be eligible for forming the plan contribution basis that is eligible for the maximum premium calculation required by the ‘incidental benefits rule’ (maximum cummulative premium of 50% of plan contributions for non-Universal Life permanent insurance….25% for term and UL), that allows life insurance to be held in a QRP. This is an opinion from the BenefitLink discussion forum on this topic:
[i]”Furthermore, under Rev. Rul. 57-213, the amount of premiums that may be used to provide an incidental level of insurance coverage is determined with regard to the “total contributions and forfeitures” allocated to the participant’s account. Because rollover money is neither a “contribution” nor a “forefeiture”, no portion of the rollover money is taken into consideration when determining the amount of premiums that may be used to provide an incidental level of insurance coverage.”[/i]
Also, the annual mortality expense (from Table 2001) will be W2 income each year, and I believe that the accumulated cash value within the LI is an asset of the KEOGH, and therefore would be taxable when withdrawn…..the pure insurance (the difference between the death benefit and accumulated cash value) would not be taxable upon death.
If lump sums are used to purchase the insurance, it would have to meet the cash corridor tests. I do not know what would happen if the premiums failed the 7-pay test within a QRP.
You can count on hefty expenses.
This is a transaction that may sound simple and of value in avoiding tax….but I wouldn’t go into this without an opinion from one who is knowledgable in ERISA law and is not being compensated by a sales commission. A mistake here could result in the IRS declaring the transaction a distribution, subject to back taxes, prior year excess contributions, and so on.
BruceM