Life and Death Planning for Retirement Benefits

Chapter 11: Insurance, Annuities, and Retirement Plans

473

Policies already in place prior to January 29, 2002, will apparently not have to meet this strict standard of proof. However, it is not clear what standard of proof will apply to such policies, since there was no IRS definition of “insurer’s one-year term rates” prior to Notice 2002-8. Also, it is not clear whether modifying an existing plan-owned policy, or swapping it for a replacement policy, would be considered entering into a new arrangement.

Current Insurance Cost: Term life insurance

The discussion at ¶ 11.2.01 – ¶ 11.2.03 deals with life insurance policies that have a cash surrender value, such as “whole” or “universal” insurance. A “term” life insurance policy has no cash value; thus, it provides only the “pure insurance protection” that is considered taxable when provided by a QRP. In the case of group term life insurance, the actual annual premium paid, rather than the Table 2001 cost, is considered the Current Insurance Cost; see Rev. Rul. 54-52, 1954-1 CB 150. It is not clear whether the Notice 2002-8 rules apply to individual term life insurance policies, or only to policies that provide something (such as cash value or annuity benefits) in addition to the pure insurance protection. Possibly, the actual premium of a term life policy, rather than the Table 2001 cost, is considered the Current Insurance Cost, as is true for a group policy under Rev. Rul. 54-52. Generally, the amount included in the employee’s gross income over the years on account of the Current Insurance Cost is “considered as premiums or other consideration paid or contributed by the employee…with respect to any benefits attributable to the contract.” In other words, it becomes his “investment in the contract” (similar to tax “basis” in other types of property). The exception to this rule is that an owner-employee does not get to treat even the Current Insurance Cost as investment in the contract. Reg. § 1.72-16(b)(4) . Definition of “Owner-employee” An owner-employee is the sole proprietor of an unincorporated business, or a partner “who owns more than 10 percent of either the capital interest or the profits interest” in the partnership. § 401(c)(3) . The author has found no rule as to when the 10 percent test for determining owner- employee status is applied; do we test only at the end of the plan year? Or must we determine whether the individual owned more than 10 percent of the capital at any time during the year? And is the test applied yearly? Or is the individual considered forever an owner-employee if he was ever an owner-employee? The employee is entitled to recover his investment in the contract income tax-free, but only with respect to benefits he receives under the policy itself . Reg. § 1.72-16(b)(4) . If the policy lapses, or is surrendered for its cash value at the plan level, the investment in the contract disappears and cannot be offset against other plan distributions. If the policy is sold to the employee ( ¶ 11.3.04 ), he may not be able to reduce the price he pays by the amount of his investment in the contract, depending on how the bargain sale ( ¶ 11.3.03 ) and prohibited transaction ( ¶ 11.3.05 , #2) rules apply to the purchase. Thus, the payment of income taxes (or a share of premiums) over the years generates an “investment in the contract” that may or may not be recouped later. Current Insurance Cost: Investment in the contract