There are several reasons that a planner may consider removing life insurance from a qualified retirement plan. Understanding the possible reasons can help you make wiser policy and financial decisions. These include the following:
- Fund assets can be invested more profitably in an alternative manner.
- It is more likely that the assets can be safely excluded from the participant’s estate.
A life insurance policy may be distributed from a plan to: (a) the insured (who must also be a plan participant); or (b) a relative of the insured participant (who is also a beneficiary under the policy). In addition, it may be distributed or sold to a trust established by or for the benefit of the insured participant or a relative of the plan participant.
The tactics to remove a policy from a qualified plan will depend on whether the policy is term or permanent life.
If the policy is a term policy, the intended third party owner (e.g., the participant’s irrevocable trust or child) should purchase a new term contract. Once it is in force, allow the term policy inside the retirement plan to lapse. (Of course, this assumes the participant is insurable at standard rates. If the participant is insurable only at a high rating or is uninsurable, use the procedure for whole life.)
If the policy is a permanent policy, sell the policy to the insured or the insured’s trust. However, note that under 2005 guidance, the value of the policy coming out of the plan is determined under special rules. If sold to the insured, the insured can then make a gift (i.e., a transfer of the policy for love and affection) to the third party who is meant to be the eventual owner and beneficiary. However, this two step process will result in estate inclusion of the policy is the insured does not survive for three years. Alternatively, if the sale is made directly to the insured’s irrevocable trust, the three-year rule can be avoided. However, in order to avoid the deadly impact (proceeds lose income tax free status) of the transfer for value rule, the trust will need to be a partner of the insured or be a intentionally defective grantor trust with respect to the insured.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM