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Discuss the implications of using life insurance to fund a qualified plan relative to the incidental death benefit test.
Expert Answer
One of the advantages offered by qualified retirement plans is the ability to acquire life insurance on plan participants using existing plan assets and future contributions to pay the premiums. This allows the plan to obtain life insurance coverage on plan participants with tax-deductible dollars. One stipulation is that this feature has to be offered to all plan participants. With self-directed 401(k) profit sharing plans, the decision should be needs-based – meaning the coverage should be obtained only on those participants who need it and wish to have it.
The qualified plan is the owner of the policy and the participant is the insured. The participant has the right to name a beneficiary – typically the spouse and/or the children of the participant.
Potential prospects for permanent life insurance-based qualified retirement plans include the following:
- Business owners who would like to purchase life insurance with tax-deductible dollars
- Individuals seeking to maximize retirement plan contributions and deductions (see discussion about 412(e)(3) plans below)
- Individuals who are adversely rated and for whom the tax deduction may help offset the higher premium cost
- Individuals in need of life insurance and a retirement savings program who have a limited budget
- Business owners interested in funding a buy/sell agreement with tax-deductible dollars utilizing a profit sharing plan. Note: The surviving business owner can be named the beneficiary on the policy providing the funds needed to purchase the business interest from the estate of the deceased business owner.
