News & Information

 

FEATURED PRODUCT

5500 Preparer's Manual for 2012 Plan Years

5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.

Learn More »

CCH® PENSION AND BENEFITS — 7/13/07

IRS instructs 412(i) insurance plans how to become retroactively subject to 412 funding rules

The IRS has released instructions that a purported Code Sec. 412(i) plan may use to be retroactively considered a plan subject to the Code Sec. 412 funding standards. A Code Sec. 412(i) plan is a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires. Code Sec. 412(i) plans are not subject to the funding rules that apply to other defined benefit plans if they meet all of the requirements of Code Sec. 412(i).

Over the years, some taxpayers have attempted to use the special 412(i) funding rules to take excessive deductions and to avoid taxes they properly owe. Other purported 412(i) plans have failed to follow the specific rules that apply to 412(i) plans, even though the deductions they have taken have generally not been greater than the deductions that would have been allowable if the plan not claimed to be a 412(i) plan. The defects, however, must be corrected in all instances.

Previous IRS guidance has addressed situations in which specially designed life insurance policies, often used in conjunction with Code Sec. 412(i) plans, are used to artificially increase the deductible contributions to retirement plans while greatly reducing the amount taxable when the policies are distributed to the plan participant.

The prior guidance has targeted three specific areas.

  1. IRS final regulations provide that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value. For this purpose, the fair market value of the contract includes the value of all rights under the contract, whether or not guaranteed, including any supplemental agreements.
  2. An IRS revenue ruling provides that an employer cannot buy excessive life insurance (i.e., insurance contracts where the death benefits exceed the death benefits provided to the employee’s beneficiaries under the terms of the plan, with the balance of the proceeds reverting to the plan as a return on investment) in order to claim large tax deductions.
  3. Another IRS revenue ruling provides that a Code Sec. 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly paid employees.

For example, some firms have promoted an arrangement where an employer establishes a section 412(i) plan under which the contributions made to the plan, which are deducted by the employer, are used to purchase a specially designed life insurance contract, generally available only to highly compensated employees. The insurance contract is designed so that the cash surrender value is temporarily depressed, so that it is significantly below the value of the premiums paid. The contract is distributed or sold to the employee for the amount of the current cash surrender value during the period in which the cash surrender value is depressed. The contract, however, is structured so that the cash surrender value increases significantly after it is transferred to the employee. Use of this springing cash value life insurance gives employers tax deductions for amounts far in excess of what the employee recognizes in income.

The IRS has previously announced that it will permit taxpayers to treat pension plans purporting to be 412(i) plans as if the plans had never claimed to be 412(i) plans. Under this option, minimum required and maximum deductible contributions are calculated for all plan years in accordance with the funding rules applicable to defined benefit plans that do not meet the requirements of 412(i), “the section 412 funding rules.” The calculations must be completed retroactively for all years back to the inception of the plan.

For more information on this and related topics, consult the CCH Pension Plan Guide.

Visit our News Library to read more news stories.