Tax Planning With Life Insurance in a Qualified Plan
By Alibaster Smith
Life insurance isn’t just for private purchase. Inside of a qualified retirement plan, a life insurance policy is a powerful retirement planning tool. A 412i plan gives you the ability to defer income for your employees and provide a guaranteed pension. However, you should understand the rules associated with buying life insurance inside of a qualified plan.
Topic To Tax Planning With Life Insurance in a Qualified Plan:
- Pension Plan
- Retirement Annuity Policy
To Tax Planning With Life Insurance in a Qualified Plan Difficulty:
- Moderately Easy
To Tax Planning With Life Insurance in a Qualified Plan You’ll Need:
- None
To Tax Planning With Life Insurance in a Qualified Plan Instructions:
- Restrictions – Not all qualified plans may purchase life insurance policies. Individual retirement arrangements (IRAs), 401k plans, annuities and other retirement accounts or retirement-based accounts are not permitted to use life insurance this way. Only 412i plans may purchase life insurance as an investment for pension purposes. This means that only an employer may set up a pension that is funded by life insurance for the purposes of providing a pension to the employee. Additionally, employees may not contribute to the pension.
- Type – Only fixed life insurance and annuity policies may be used in 412i plans. All insurance policies must be guaranteed to return a specific rate of return. Pension funds cannot be endangered by poor or negative performance. This ensures that the plan stays compliant with the IRS rules regarding 412i plans and defined benefit payments made during retirement. The only fixed life insurance policies sold in the life insurance industry are whole life and fixed universal life. Therefore, these are the only policies allowed inside of a 412i plan.
- Limitations – The 412i plans are not permitted to use life insurance policies where more than 50 percent of the contribution goes toward purchasing life insurance for the employees. The death benefit must be incidental to the pension plan. Once the contributions exceed this 50-percent threshold, the 412i plan must contribute the remaining amount of money to fixed annuity policies.
- Consideration – Tax planning, by using life insurance, is accomplished by deferring as much compensation into the 412i plan as is allowed by the IRS. The death benefit of the life insurance policy returns funds to the company, if it’s the beneficiary, thus replenishing the source of funds initially used to fund the pension plan. This cycle continues, with the employer paying premiums to the policy on a tax-deductible basis. This makes the policy tax-efficient, since the life insurance death benefit may be made large enough to pay all taxes and return all 412i contributions to the company upon the death of the employee. This makes the plan self-completing after the first generation of employees passes away.