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Treasury Goes After Aggressive 412(i) Plans

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NU Online News Service, Feb. 13, 2004, 4:52 p.m. EST, Washington – The U.S. Treasury Department is going after aggressive 412(i) retirement plans.[@@]

The department has tackled what it says are abuses in the 412(i) plan market by proposing a regulation that would affect transfers of life insurance contracts from an employer or tax-qualified plan to an employee. Under the proposed regulation, any such transfer would have to be taxed at its full fair market value.

Section 412(i) of the Internal Revenue Code lets employers use guaranteed life insurance policies and annuity contracts to fund simple defined benefit retirement plans.

Treasury says its proposal will prevent taxpayers from using artificial devices to understate the value of the life insurance policies and annuity contracts used to fund 412(i) plans.

“The guidance targets specific abuses occurring with Section 412(i) plans,” says Pam Olson, an assistant Treasury secretary. “There are many legitimate Section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements.”

Employers can deduct 412(i) plan contributions from taxable income. The plan must use the contributions to pay for the insurance contracts and annuities that will fund the pension benefits.

The plan may hold a contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.

Treasury says some firms have set up 412(i) plans for highly compensated employees that use plan contributions to buy life insurance contracts designed so that the cash surrender value temporarily will be depressed to the point that it is significantly below the value of the premiums paid.

The contract then is distributed or sold to the employee for the depressed amount of current cash surrender value, Treasury says.

But the policy is structured in such a way that the cash surrender value increases significantly after the transfer, Treasury says.

Use of this “springing cash value life insurance” gives employers tax deductions for amounts far in excess of what the employee recognizes in income, Treasury says.

The proposed regulations, which will be effective for transfers made as of Feb. 13, 2004, will prevent the use of this device, Treasury says.

In addition, Treasury issued a revenue ruling stating that Section 412(i) plans cannot use differences in life insurance contracts to discriminate in favor of highly paid employees.

A second revenue ruling issued by Treasury says an employer cannot buy excessive life insurance simply to claim large tax deductions.

The arrangements subject to the second ruling are those designed so that the contract death benefits exceed the death benefits provided to the employee’s beneficiaries under the terms of the plan, with the excess reverting to the plan as a return on investment.