256 / What is a retired lives reserve? Is an employee taxed on employer contributions to such a reserve? May an employer deduct contributions to a reserve?

A retired lives reserve is a fund for continuing group term life insurance on retired employees. Employer contributions to a reserve should not be taxable to a current employee if he or she has no present interest in the fund, which means that the employee is not in actual or constructive receipt of any part of the fund or of a current economic benefit.

When an employee retires, the present value of any future group term life insurance coverage that may become non-forfeitable on retirement, or the value of the amount set aside by an employer to fund such coverage, will not be taxed to the employee immediately on retirement. The cost of group term insurance will be included in the income of a retired employee under IRC Section 79 in the year in which the coverage is received, regardless of whether the coverage vests upon retirement.¹

Contributions to a retired lives reserve to fund postretirement life insurance benefits over the working lives of covered employees may be subject to limits on deduction of contributions to welfare benefit funds ( Q 4092). Temporary regulations provide that certain retired lives reserves maintained by an insurance company are “funds” ( Q 4090)² and contributions to a fund to provide postretirement life insurance for a key employee must be accounted for separately ( Q 4098).

The conclusion reached in one letter ruling was that there was no income to an employer arising out of:

(1)     an employer’s assignment to an IRC Section 501(c)(9) trust, a voluntary employees’ beneficiary association, of all its rights in an insurance policy under which the insurer maintained a retired lives reserve;

(2)     an agreement by a trustee with an insurance company that amounts credited to a reserve would be invested under the general direction of the trustee in a separate account of the insurer or used to purchase annuity contracts; and

(3)     payments to a trustee under annuity contracts to be used to provide group term life insurance for retired employees.

The conclusion reached in the ruling was based on the fact that at the time of the transfer the employer had no right to recover the reserve as long as any active or retired employee remained alive and the possibility of reversion was unrealistic because of the large number of employees ( Q 4100).³

If a plan provides life insurance benefits exclusively for retirees, legislative history indicates that the plan will be considered to be a deferred compensation plan.⁴ An employer’s deduction would be limited under IRC Section 404(a)(5) to the amount includable in an employee’s income, and allowed only if separate accounts are maintained for each covered employee.