Is a Policy Inside a Qualified Retirement a Good Idea?

Qualified retirement plans are designed to encourage employees to save money, so that they will have enough when they are no longer working. In simpler terms, this type of plan is a tax-favored accumulation vehicle like permanent (cash value) life insurance.

However, paying life insurance and annuity premiums with qualified-plan dollars is quite controversial. Why put an accumulation vehicle that enjoys tax-deferred treatment inside a plan that, by definition, is tax deferred?

Every situation is different; some may benefit from a plan life this while others may not.

A good place to start is by looking at a 403(b) plan, which is a tax-deferred retirement plan for employers of school and other nonprofit organizations. These plans are also known as tax-sheltered annuities, even though the term includes mutual funds and “incidental” life insurance.

The rules for selling life insurance inside a 403(b) plan are fairly loose.

A participant can use up to 50% of the aggregate contributions made to a 403(b) plan to purchase whole life insurance. In the case of universal life insurance, only 25% of the aggregate contributions can be used to purchase a policy.

For example, consider that a tax-sheltered annuity participant has accumulated $100,000.

Then suppose a producer persuades the participant to use $49,000 to pay for a whole life insurance policy.

The result – life insurance sales charges and other expenses eat up a lot of participant dollars, which otherwise could be growing toward a retirement fund. Also, there is no question that this sale earned the producer a nice commission.

Arguments that favor buying life insurance with qualified-plan dollars:

· The life insurance is purchased with pretax dollars

· The life insurance provides a self-completing financial and/or estate plan.

· The participant may keep the policy after retirement (by paying income tax on the cash value).

· Premiums can be paid from previously accumulated contributions.

· If no longer needed, the life insurance cash value can be transferred to an annuity contract.

· The participant can borrow the cash value subject to Internal Revenue Service Code Sec. 72(p) rules.

· The life insurance company calculates the annual cost of insurance that must be included in the participant’s taxable income.

Arguments against buying life insurance with qualified-plan dollars:

· It is more of a commission-driven than a need-oriented sale.

· The mortality charge introduced an additional cost element when compared with an annuity or mutual fund. (Annuities on which the surrender charge is waived upon death contain a mortality element, but it is small enough to ignore for our purposes.)

· It is an attempt to fill a permanent need with temporary coverage. The life insurance policy must be distributed by the plan at retirement and income tax paid on it, or it must be converted to an annuity payout or surrendered.

· Income tax must be paid each year on the current cost of the “incidental” life insurance element.

· It uses up the participant’s 403(b) contribution limit – called the exclusion allowance.

· All other things being equal, a lot less money will be accumulated when life insurance is used as the accumulation vehicle.

Tony Steuer is an author and advocate for financial preparedness. Tony Steuer, CLU, LA, CPFFE, helps people make sense of the financial world in a way that’s easy for them to understand. His books including, “GET READY!,” “Insurance Made Easy,” and “Questions and Answers on Life Insurance,” have won numerous awards. Tony is the founder of the GET READY! Initiative which includes the GET READY! financial organization system, the GET READY! Financial Preparedness Club, GET READY! Podcast, and the GET READY! Financial Principles, a best practices playbook for the financial services industry. Tony served as long-term member of the California Department of Insurance Curriculum Board. Tony is regularly featured in the media including the New York Times, the Washington Post, Fast Company, and other media. He has also appeared as a guest on television shows, such as ABC’s “Seven on Your Side.” Visit to join the GET READY! Financial Preparedness Club and access free resources.

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