Update on 412(i) pension plans for 2004

by Tony Novak, MBA, MT, OnlineAdviser at Freedom Benefits revised 11/27/11

The IRS clarified three important points for pension plans that use life insurance in February 2004:

1. A tax-qualified pension plan may not provide life insurance benefits in excess of the previously stated maximums. In general, this maximum amount is 100 times the monthly pension benefit.

2. The cost of life insurance that is more than the allowable amount is not tax deductible as a current year’s contribution to the retirement plan.

3. Life insurance contracts may not be sold or transferred out of a pension plan for the amount of their cash value that is significantly less than the amount paid for the insurance policy.

While pension plans may contain some life insurance to provide incidental death benefits, some life insurance promoters have used life insurance almost exclusively to fund pension plan benefits. Some companies incorrectly promoted life insurance policies as a way to increase tax-deductible contributions to a pension plan. The IRS has consistently held that such practices were abusive. The current rulings issued in February 2004 are designed to clarify these positions. Details can be found in Revenue Ruling 2004-20, 2004-21 and Revenue Procedure 1004-16.

Business owners with pension plans that are funded primarily with life insurance should seek advice from a source other than the life insurance sales system. Those who relied on advisory or legal services provided by the life insurance company may wish to raise the question as to whether the advice was objective and consistent with industry standards.

Some businesses will eventually be hurt financially by enforcement of these new revenue rulings. Attorneys seeking to substantiate charges of improper sales practices may wish to gather evidence of IRS statements and industry publications on the topic of these abusive practices issued prior to the date of sale of the life insurance policy.

Tony Novak is a member of the Pennsylvania Institute of Certified Public Accountants, the New Jersey Society of Certified Public Accountants and an accredited member of the Better Business Bureau.

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