Complete Pension Plans With Life Insurance

(5) Only life insurance provides for an optional settlement payment of a guaranteed life annuity to the plan participant’s designated beneficiary. The beneficiary can convert pension plan death benefits from a lump sum payment into a lifetime income stream.

(6) Life insurance death benefits can avoid the potential “double taxation” risk that affects pension account values that are payable at death to named beneficiaries. Classified as income in respect of a decedent, pension values are subject to both estate and income tax consequences (IRC Section 691). An itemized deduction for estate taxes allocated to the survivor beneficiary’s income benefit may alleviate but not preclude the income taxation of these benefits. As previously mentioned, the net amount of risk death benefit received by the plan participant’s beneficiary is not subject to income taxation.

According to Treasury Regulations (Reg. 1.401-1(b)(1)(i)), pension life insurance benefits must be “incidental” to the primary purpose of the plan, which is to provide retirement benefits.

Generally these rules are satisfied by limiting the plan contribution amounts allocated to life insurance premiums to less than 25% or 50% of the plan contribution, depending upon the nature of the life insurance contract purchased. The 25% allocation is applicable to current term coverage and to universal life type contracts. The 50% allocation is applicable when the pension trustee purchases an ordinary life insurance contract.

These incidental percentages can be exceeded in properly designed profit sharing and defined benefit pension plans. All funds accumulated in a profit-sharing account for at least 2 years can be used to fund the premiums of a life insurance policy (Revenue Ruling 71-295) without regard to the incidental percentage limits.

Also, a profit-sharing plan can permit all employer contributions to be used for premium payments once the employee insured has been a participant in the plan for at least 5 years. Another type of fully insured pension plan is the IRC Section 412(i) guaranteed defined benefit plan.

Properly structured profit sharing plans can even be designed to use corporate tax deductible contributions to fund a cross purchase buy-out agreement between two or more owners.

Life insurance adds both a cost and tax effective element to all pension plans. The insurance policy’s death benefits make the pension plan more cost effective for funding a survivor legacy. And, the IRC 101 tax free treatment of the net amount at risk of the policy’s death benefit make the pension plan more tax effective.

After the Enron debacle, employees and employers alike are becoming increasingly sensitive to the need to diversify pension plan assets and avoid the over-weighting of those assets in an employer’s stock. The purchase of variable universal life insurance with a wide range of diversified, professionally managed investment options may be a solution.

Of even greater importance, however, is the added financial security that can be provided to an employee’s beneficiaries by insuring and enhancing their survivor benefits with a “complete” retirement plan.

John S. Budihas, CLU, ChFC, CFP is a business, estate and trust planning consultant for the individual life division of Hartford Life Insurance Co., a subsidiary of The Hartford Financial Services Group, Inc. He can be reached at john.budihas

Reproduced from National Underwriter Life & Health/Financial Services Edition, April 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.