3990 / What are the PTEs that establish conditions for the transfer of life insurance and annuity contracts to and from plans?

Administrative Exemptions: 92-5 and 92-6

Prohibited Transaction Exemptions 92-5 and 92-6¹ establish conditions for the transfer of life insurance and annuity contracts to and from plans. PTEs 92-5 and 92-6 extended the relief granted under PTEs 77-7 and 77-8 to owner-employees and to shareholders owning more than 5 percent of the outstanding stock in an S corporation. PTE 92-5 permits individual contracts to be transferred to a plan by participants or employers, any of whose employees participate in the plan. The plan generally must pay no more than the lesser of the cash surrender value of the contract or the value of the participant’s accrued benefit at the time of the transaction (or account balance, in the case of a defined contribution plan), and the contract must not be subject to any loan that the plan assumes. The DOL has stated that where participants transfer individual policies that have no cash surrender value, the transfer will not violate the prohibited transaction rules where the plan pays no consideration for the
policies.²

PTE 92-6 enables a plan to sell insurance contracts and annuities to a plan participant insured under the policies, a relative of such participant who is a beneficiary under the contract, an employer whose employees are covered by the plan, or another employee benefit plan for the cash surrender value of the contracts, provided certain conditions are met. In the absence of these exemptions, these transfers would be prohibited transactions.

PTE 92-6 first was clarified in 1998 so that, if all of its other conditions are met, two or more relatives who are the sole beneficiaries under a contract may be considered a single relative and an individual life insurance contract may be read to include a contract covering the life of the participant and his or her spouse (if permitted by applicable state insurance law, other applicable law, and pertinent plan provisions). In addition, a sale of a partial interest in a life insurance contract qualifies as a sale of an individual life insurance contract if certain requirements are met with both the portion sold and the portion retained.³

In 2002, PTE 92-6 was retroactively amended to permit transfers of life insurance contracts directly to life insurance trusts and certain other trusts.⁴ In addition, the DOL clarified that second-to-die policies covering spouses are included within the scope of PTE 92-6.⁵

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Planning Point: This expansion and liberalization by the Department of Labor adds trusts to the list of those to whom life insurance owned by a qualified plan can safely be sold. It is important to note that the exemption is conditioned on the fact that, but for the sale, the plan would have surrendered the life insurance contract. Furthermore, the plan must be paid what the policy is worth at the time it is sold.

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The preamble to PTE 77-8⁶ (which was replaced by PTE 92-6) noted that, for federal income tax purposes, the value of an insurance policy is not the same as, and may exceed, its cash surrender value, and that a purchase of an insurance policy at its cash surrender value therefore may be a purchase of property for less than its fair market value.

In 2004 guidance, the Treasury Department clarified that under new proposed regulations, any such bargain element will be treated as a distribution under IRC Section 402(a) as well as for other purposes of the IRC, including the limitations on in-service distributions from certain qualified plans and the limitations of IRC Section 415.⁷

The DOL also has extended the application of PTE 92-6 to the transfer of a second-to-die policy owned by two spouses from a self-directed profit sharing plan account, provided certain requirements are met. Generally, the requirements are that the participant must be the insured under the contract, the contract would be surrendered but for the sale by the plan, and the amount received by the plan as consideration must be at least equal to the amount necessary to put the plan back in the same position as if it had retained the contract, surrendered it, and made any distribution owed to the participant on his or her vested interest under the plan.⁸