Please help! A plan must rid itself of life insurance contracts, which are owned by 9 plan participants. One option is to allow the 9 to purchase the contracts from the plan, by complying with the DOL rules to avoid prohibited transaction problems. In order to do that, the 9 must pay the cash surrender value of the policies to the plan. If they do that, is the distribution of the policies to them taxable income? Any cites would be appreciated.

Also, the plan can borrow against the policy to reduce the cash surrender value of the policies, thereby making it easier for them to be purchased by the plan. I assume the loan proceeds are deposited into the participant's account? What happens to the loan when the policy is then distributed to participants?

If the participant's purchase the policies, the plan has sold the asset, not distributed it so there is no taxable distribution. If the plan takes out policy loans first, the proceeds would go into the individual participants account if it is an individual account plan and the policies are currently only a part of their individual accounts. The policy loan would stay with the policy and the individual would then assume the policy loan obligation along with the premium obligation after buying the policy for the remaining surrender value.