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IRS Issues Guidance On Valuation Of Life Insurance In Qualified Plans

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The guidance provides a formula for determining fair market value

The Internal Revenue Service has issued additional guidance for the valuation of life contracts in qualified plans to clarify some questions raised by the industry regarding earlier guidance.

The IRS initially had put out its guidance on the issue in February of last year, but the American Council of Life Insurers and others raised questions regarding some of the safe harbor provisions. The recently issued guidance, according to ACLI senior counsel Mark Canter, seems to answer many of those questions.

“Initially it does address a number of the issues we raised,” he said. However, he added, the ACLI is “still working through” some of the complexities of the guidance.

The new guidance, Canter said, provides a formula for determining the fair market value. That formula, as outlined in the new guidance, consists of premiums paid plus interest, dividends or other credits minus “reasonable mortality and other reasonable charges actually charged” by the date of distribution or transfer that are expected to be paid. For variable contracts, the guidance establishes fair market value as cash value without reduction for surrender charges provided that cash value is at least equal to the total premiums paid plus all adjustments made to those premiums reflecting investment return and the value of segregated asset accounts, minus reasonable mortality and other charges actually charged by the date of determination.

Canter noted that although the new guidance answered many questions, some issues, such as those involving the treatment of surrender charges, remain. The guidance does, however, state that the formulas it suggests should never be used to understate the fair market value of an insurance contract.

The IRS stated in the guidance that taxpayers can rely on the safe harbors it established for distributions, sales or other transfers taking place after Feb. 13, 2004, and before May 1, 2005. Canter noted that going forward, since the guidance was put out as a “revenue procedure” rather than a proposed rule, the process for seeking further changes is more open. “I expect to the extent that we can identify any further issues and communicate them to the IRS quickly, they can be addressed,” he said.

Officials of the Association for Advanced Life Underwriting said the final rule was revised substantially from the proposal as a result in part of oral and written testimony the trade group and its members provided the IRS.

The AALU said that, in testimony by executive committee member Larry Raymond and others, it supported the safe harbor approach to valuation of life insurance contracts for qualified plan, employee benefit, and estate and gift tax purposes, but “we objected vigorously to the proposed safe harbor’s lack of recognition for surrender costs and proposed a formula that would provide a reasonable acknowledgement of these costs.”

The AALU also urged consideration of other forms of valuation, such as reserve standards, an official explained.

The final valuation formula is a “variation of our presentation at the hearings,” an AALU official said, adding that, “we have not yet had the opportunity to test the new rule in various circumstances to confirm that it, in fact, offers a useful method for reflecting surrender costs. After further review, we will examine what further input and response from AALU may be needed.”


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