Using life insurance in qualified plans
By Steve Savant
Profit sharing retirement plans allow 25 percent to 50 percent of annual contributions to be used for life insurance premiums. So-called seasoned money can all be put towards life insurance premiums.
Modified endowment contract status is not a problem in a qualified plan because there is no tax on liquidation of the policy inside a plan. Of course, all distributions from the plan are ordinary income for income tax purposes. If the policy is distributed later from the plan instead of cash you may need to keep the policy from becoming a MEC.
The economic value of the policy’s life insurance benefit and the excess premium for permanent life insurance is taxable to the participant. The life insurance death benefit in excess of the cash values at death are income tax free. The cash value is taxable to the extent it exceeds the reported and previously taxed table 2001 reported income over the years.
So the net effect is a portion of the premiums net out to be deductible through this mechanism.
This is especially helpful when the participant is poorly rated medically. Table 2001 uses standard rates and therefore taxes smaller amounts than the real value of the benefit. So keep this in mind for owners with poor health that can still be medically underwritten. This is a good place to find free cash to fund life insurance benefits.
Also, old IRA money can be ported tax free, in most cases, into a new profit sharing plan where the IRA owner has a business that can set a new plan up. Then the money can be used to buy life insurance.
In addition to the cash values being competitive and relatively safe, the life insurance benefits and living benefits can be quite attractive to older IRA owners.
We find older business owners are concerned about future medical costs such as the potential cost of long term care. They like the safer cash value cash accumulation that indexed and fixed life insurance can offer even with the costs.