3814 / Are there any limits on the amount of life insurance that a fully insured (412(i)) plan can purchase to fund the plan?

A 412(i) plan must limit the amount of life insurance that can be provided under the plan. A failure to meet this requirement is a qualification failure that could lead to a disqualification; it also may result in the plan becoming a listed transaction.

The IRS has provided guidance illustrating two circumstances under which fully insured (Section 412(i)) plans have purchased excessive amounts of life insurance.¹ In the first example, the participant’s benefit payable at normal retirement age was not equal to the amount provided at normal retirement age with respect to the contracts held on behalf of that participant. The IRS ruled that such a plan fails to satisfy the requirements of IRC Section 412(e)(3)(C), as redesignated by PPA 2006. Accordingly, although the plan still can be a qualified defined benefit plan, it must satisfy the other requirements of IRC Section 412, including reasonableness of actuarial assumptions.

In the second example, the life insurance contracts on the life of a participant provided for death benefits in excess of the death benefit provided to that participant under the plan. In the example, on the employee’s death, proceeds in excess of the death benefit payable to the employee’s beneficiary were applied to the payment of premiums with respect to other participants.

The IRS ruled that the portion of contributions attributable to excess coverage did not constitute “normal cost” and thus, was not deductible. Similarly, contributions to pay premiums for the disability waiver of premium feature with respect to such excess coverage were not deductible. Instead, such amounts are carried over to later years.

With respect to the excess coverage, the IRS stated that such premiums could be carried over and treated as contributions in later years. They are deductible in years when excess death benefits are used to satisfy the employer’s obligation to pay future premiums on other participants. It should be noted that nondeductible contributions are subject to a 10 percent excise tax under IRC Section 4972 ( Q 3943).

Transactions that are the same as or substantially similar to the second example (in which excessive death benefit coverage is held) are classified as “listed transactions” if the employer has deducted amounts used to pay premiums on a life insurance contract with a death benefit exceeding the participant’s death benefit under the plan by more than $100,000.²