Life insurance in a qualified plan: The basics you must knowBlog added by Nicholas Paleveda MBA J.D. LL.M on July 30, 2014
Nick Paleveda MBA J.D. LL.M

Nicholas Paleveda MBA J.D. LL.M

Sanford, NC

Joined: March 27, 2012

Buy life insurance with a tax deduction?

Generally, the answer is no! This is due to section 264 of the internal revenue code which does not allow for life insurance to be purchased on a tax-deductible basis.

See also: Why buying life insurance in a qualified plan is a terrible idea

However, if you set up a qualified plan you can purchase the insurance tax-deductible — and the answer is now yes!

Life insurance is "incidental"

First, realize that the life insurance is an "incidental benefit of the plan." The primary benefit must be for retirement, hence Rev. Rul. 74-307, which states that no more than 50 percent of the contribution may be used to purchase a whole life product and no more than 25 percent must be used for universal life. Forget term — it has no retirement benefits, so zero for the termites. The balance of the account may be used to purchase annuities or investments. The alternative rule is the death benefit may provide for no more than 100 times the monthly earnings at normal retirement age. If your plan has a $7,000-a-month retirement benefit, you may purchase insurance with a death benefit of $700,000.

Use a profit sharing plan or defined benefit

Second, the plan may be a profit sharing plan or a defined benefit plan. If the plan is a profit sharing plan, no more than 25 percent of the participant salary may be used to fund the plan — up to $52,000. For example, if your client makes $100,000 a year, the most that may be contributed into the plan is $25,000, which means the maximum contribution into a whole life policy will be $12,500. If your client earns $200,000, the maximum into the plan is $50,000 and the maximum into a whole life insurance is $25,000. However, if a defined benefit plan is established — and your client is older — a salary of $50,000 may support a $50,000 contribution into the plan and you may be able to place $25,000 into the whole life. A contribution to a defined benefit plan is calculated by an actuary.

Use a TPA

Third, a third party administrator (TPA) can help you with the plan design, establishing the legal documents, obtaining the tax ID number and filing of the form 5500. The actuarial calculations must also be performed. If you do not include the P.S. 58 amounts, the entire contribution is tax-deductible. However, the death benefit will be distributed taxable to the participant's beneficiary. Set up and administration cost may be offset with a $500 tax credit for three years.
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