Life and Death Planning for Retirement Benefits

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Table of Contents 451
Policies already in place prior to January 29, 2002, will apparently not have to meet this
strict standard of proof. However, it is not clear what standard of proof will apply to such policies,
since there was no IRS definition of “insurer’s one-year term rates” prior to Notice 2002-8. Also,
it is not clear whether modifying an existing plan-owned policy, or swapping it for a replacement
policy, would be considered entering into a new arrangement.
11.2.04 Current Insurance Cost: Term life insurance
The discussion at deals with life insurance policies that have a cash
surrender value, such as “whole” or “universal” insurance. A “term” life insurance policy has no
cash value; thus, it provides only the “pure insurance protection” that is considered taxable when
provided by a QRP.
In the case of group term life insurance, the actual annual premium paid, rather than the
Table 2001 cost, is considered the Current Insurance Cost; see Rev. Rul. 54-52, 1954-1 C.B. 150.
It is not clear whether the Notice 2002-8 rules apply to individual term life insurance
policies, or only to policies that provide something (such as cash value or annuity benefits) in
addition to the pure insurance protection. Possibly, the actual premium of a term life policy, rather
than the Table 2001 cost, is considered the Current Insurance Cost, as is true for a group policy
under Rev. Rul. 54-52.
11.2.05 Current Insurance Cost: Investment in the contract
Generally, the amount included in the employee’s gross income over the years on account
of the Current Insurance Cost is “considered as premiums or other consideration paid or
contributed by the employee…with respect to any benefits attributable to the contract.” In other
words, it becomes his “investment in the contract” (similar to tax “basis” in other types of
property). The exception to this rule is that an owner-employee does not get to treat even the
Current Insurance Cost as investment in the contract. Reg.
Definition of “Owner-employee”
An owner-employee is the sole proprietor of an unincorporated business, or a partner “who
owns more than 10 percent of either the capital interest or the profits interest” in the partnership.
The author has found no rule as to when the 10 percent test for determining owner-
employee status is applied; do we test only at the end of the plan year? Or must we determine
whether the individual owned more than 10 percent of the capital at any time during the year? And
is the test applied yearly? Or is the individual considered forever an owner-employee if he was
ever an owner-employee?
The employee is entitled to recover his investment in the contract income tax-free, but only
with respect to benefits he receives under the policy itself. Reg. If the policy
lapses, or is surrendered for its cash value at the plan level, the investment in the contract
disappears and cannot be offset against other plan distributions. If the policy is sold to the
employee , he may not be able to reduce the price he pays by the amount of his
investment in the contract, depending on how the bargain sale and prohibited
transaction #2) rules apply to the purchase. Thus, the payment of income taxes (or a
share of premiums) over the years generates an “investment in the contract” that may or may not
be recouped later.