Retirement and life insurance in a qualified retirement plan

“My client has a life insurance policy inside his profit sharing plan at work. He will be retiring soon. Can he leave the policy in the plan after retirement?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Wisconsin is representative of a common inquiry related to life insurance in qualified retirement plans.

Highlights of the Discussion

No, the IRS says a life insurance policy cannot remain in a plan past the plan participant’s retirement or separation from service (Revenue Rulings 54-51 and 74-307).[1] The reasoning for this relates to the IRS’s rules that holding life insurance in a qualified retirement plan is OK as long as the death benefits are “incidental,” meaning they must be secondary to other plan benefits.

Death benefits are considered incidental if the plan meets two conditions: 1) employer contributions used to purchase coverage are limited as prescribed; and 2) the plan requires the trustee to convert the entire value of a life insurance contract at or before retirement into cash, provide periodic income so that no portion of the policy may be used to continue life insurance protection beyond retirement, or distribute the contract to the participant (IRS Publication 6392, Explanation #4, Miscellaneous Provisions.)  Participants and their financial advisors should check the terms of their retirement plan documents to see what the plan language dictates.

Regarding the contribution limits, life insurance coverage in a defined contribution plan is considered incidental if the amount of employer contributions and forfeitures used to purchase whole or term life insurance benefits are limited to 50 percent for whole life, and 25 percent for term policies. No percentage limit applies if the participant purchases life insurance with company contributions held in a profit sharing plan for two years or longer.

Conclusion

The incidental benefit rules that apply to holding life insurance in a qualified retirement plan prevent the plan from retaining the policy past a participant’s retirement.

[1] See www.legalbitstream.com