Hello,

It isn't easy to find guidance on this topic, so I thought I would throw it out there. The client would like to hold universal life policies in a start-up profit sharing plan.

1. What is the percentage limit on contributions to be used to purchase such insurance? I believe it is 25% under the incidental benefit rule. I believe there is a 50% limit on other types of insurance, but I'm not exactly sure.

2. What is the percentage limit on a ROLLOVER from a SEP-IRA? I believe 25% of the rollover amount can be used to purchase such insurance, with the rest being contributed to the new plan in cash.

Any thoughts/references would be most appreciated!

Why?

We are in the plan design phase and the client is exploring all options. We want to make sure he know that there are limitations on life insurance in qualified plans. but I have not looked at this issue in years and like everything else, the rules may have changed. But I can't seem to find much on point!

If anybody has experience with this issue, I would appreciate some input.

Thanks

Yes, the UL limit is 25%. Whole life is 50%. No limit on the rollover.

Thank you so much for the reinforcement! That's what I thought. Do you happen to know where I can find a reference to the lack of a limit on the rollover contribution?

It has always been my understanding that for life insurance to be an "incidental benefit" that the cumulative premiums could not exceed 25%/50% (depending on type of insurance) of the cumulative contributions.

Assuming that's correct (?), could a rollover amount be used for premium payment?

Revenue Ruling 74-307 provides that the incidental limits apply only to insurance purchased with employer contributions. I've seen IRS approved prototypes that allow unlimited use of rollover funds to purchase life insurance in the plan. HOWEVER - be very cautious on this - and have client seek experienced ERISA counsel before taking this step - the IRS may assert that the premium paid from the rollover funds is in fact a taxable distribution. Jim Holland informally opined this many years ago, but the basis for this opinion would appear to be a bit shaky. The generally prevailing opinion that I've heard from most practitioners is that it isn't a distribution, there's no constructive receipt, etc., because the money remains in the plan, but you would, of course, have taxable term cost to report.

I posted this earlier this year in another thread. The highlighted words are only because that's what I searched on to find my post.

I've been dealing with this for a long time. Back in 1993, I asked some very specific questions and got a General Information response from Jim Holland.

Part of that letter dealt with Rollovers. Here it is:

"You also asked whether the existence of rollover money from another qualified plan would have any effect on the transaction. Again, any question regarding the income tax effect of such a transaction is beyond the scope of a general information letter. However, we wish to draw your attention to certain considerations that affect the calculation of the level of incidental insurance coverage in such a situation.

The requirement that a profit-sharing plan provide for the accumulation of funds for a "fixed number of years" is found in section 1.401-1(b)(1)(ii) of the regulations. In applying the provisions of this section of the regulations to rollover money, the instant plan is considered separate from the prior plan. (See, for example, private letter ruling 8134110, dated may 28, 1981.) Furthermore, under Rev. Rul. 57-213, the amount of premiums that may be used to provide an incidental level of insurance coverage is determined with regard to the "total contributions and forfeitures" allocated to the participant's account. Because rollover money is neither a "contribution" nor a "forefeiture", no portion of the rollover money is taken into consideration when determining the amount of premiums that may be used to provide an incidental level of insurance coverage."


I know this isn't a ruling, but it is in writing and I've never seen anything more official to contradict it.

Very helpful string of messages!

One more question - one person indicated that the IRS could consider the rollover contribution used to purchase insurance to be a taxable distribution. If the plan were to apply the incidental benefit rule broadly and consider the rollover contribution to be part of the "aggregate contributions and forfeitures," and only used 25% of the rollover contribution for purposes of purchasing insurance, would this reduce the risk of an adverse IRS finding of a taxable distribution?
For example, using $25,000 of a $100,000 rollover contribution as a premium to purchases insurance, which is then held in the plan as a plan asset. Thanks again!

If you will note in my response from Jim Holland above, rollovers are not contributions.

Yes, you did mention that. I guess I am struggling with the concept that a rollover "contribution" is not considered a type of employee contribution to the plan. The logic escapes me. In any event, would that mean that 100% of the rollover could be used to purchase insurance? It sounds very aggressive to me. Again, many thanks for taking the time to help me out!

Think of a "contribution" as something that goes toward the 415 limit. Rollover doesn't count towards that.

You can use as much of the account as you want to purchase insurance. However, there are consequences to what you do.

If you satisfy the incidental rules, then the participant just reports the PS 58 costs as taxable income.
If you don't satisfy the incidental rules, then the participant reports the entire premium as taxable income.