3952 / May the cost of life insurance protection provided under a qualified plan be recovered tax-free when benefits are paid?
If life insurance protection under a plan is provided by a cash value policy and the employee has reported the pure death benefit each year, then the total amount reported will be the basis in the contract ( Q 3948, Q 3949). That basis may be recovered tax-free if it is paid as a death benefit directly to the beneficiary of the participant.
If a contract is distributed to a participant as a benefit, then the basis in that contract is not taxable.1 It does not matter whether the contract is distributed or is cashed in and that amount is distributed. It would seem that deductible employee contributions that have been applied to purchase life insurance and taxed to the employee also would be recovered tax-free from benefits received under the policy.2 The amount recoverable is the total amount of income that has been reported, and not just the taxes paid on that income.3
Regulations say that “each separate program of the employer consisting of interrelated contributions and benefits” is a single contract. Where retirement benefits and life insurance are separately provided (e.g., through retirement income contracts and a side fund), they generally are separate programs. Thus, if insurance is provided under a separate term policy, the taxable cost cannot be recovered from the retirement benefits.4