“Is there any guidance on valuing a life insurance contract distributed from a 401(k) plan?”
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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
Highlights of Discussion
- Fortunately, there is. The IRS has provided safe harbor rules for determining the fair market value of life insurance contracts distributed from a qualified retirement plan in Revenue Procedure (Rev. Proc.) 2005-25 [1].
- Under Internal Revenue Code Section (IRC §) 402(a), amounts distributed to a plan participant, generally, are taxable in the year in which they are paid to the employee.
- Treasury regulations (Treas. Regs.) provide that the cash value of any retirement income, endowment or other life insurance contract is includible in gross income at the time of the distribution [Treas. Reg. § 1.402(a)-1(a)(2) [2]].
- However, sometimes the stated cash surrender value of a contract does not accurately reflect its actual fair market value. In Rev. Proc. 2004-16, which was superseded by Rev. Proc. 2005-25, the IRS provides a formulaic approach to valuing a life insurance contract. The IRS issued the rev. procs. primarily to address the issue of a “springing cash value plan,” a policy in which, for the first few years, the cash surrender value of the policy is much lower than the value of the premiums paid or the reserve accumulations (Internal Revenue Manual 4.72.8.5.3 [3]).
- Plan sponsors should ensure providers of life insurance contracts and plan record keepers are following the guidance of Rev. Proc. 2005-25 when determining the fair market value of a distributed life insurance contract.
Conclusion
Sometimes the stated cash surrender value of a life insurance contract does not accurately reflect its actual fair market value. Rev. Proc. 2005-25 provides a safe harbor means to calculate the fair market value of life insurance contracts.
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