Chapter 13
LIFE INSURANCE IN A QUALIFIED PLAN
LEARNING OBJECTIVES:
A. Have a basic understanding of using life insurance to fund a qualified
plan
B. Understand ways in which life insurance may be used in defined
benefit plans
C. Understand ways in which life insurance may be used in defined
contribution plans
D. Identify key tax-related factors when using life insurance to fund a
qualified plan
REVIEW:
This chapter begins by investigating when the use of life insurance in a qualified
plan may be indicated, followed by a discussion of advantages and
disadvantages. After this, the chapter has an extended section on how life
insurance may be used in both defined benefit and defined contribution plans.
Guidelines for life insurance use are discussed, including incidental death benefit
considerations. Combination plans and envelope funding are covered next,
followed by a section on fully insured plans. The chapter continues with a section
on tax implications, and brief coverage of alternatives. Finally, there is a good
question and answer section dealing with a variety of topics relating to the use of
life insurance in different types of plans.
CHAPTER OUTLINE:
A.
B.
C.
D.
E.
What is It?
When is it Indicated?
Advantages
Disadvantages
How is it Used?
1
Chapter 13
F.
G.
H.
I.
1. Insurance Coverage
2. How Much Insurance – The “Incidental” Test
3. Life Insurance in Defined Benefit Plans
a. Combination Plan
b. Envelope Funding
4. Fully Insured Plans
a. The Overfunding Problem
b. A Solution – Fully Insured Plans
c. Other Advantages
d. How Does it Work?
5. Life Insurance in Defined Contribution Plans
Tax Implications
Alternatives
Questions and Answers
Chapter Endnotes
FEATURED TOPICS:
Life insurance in defined benefit plans
Life insurance in defined contribution plans
FIGURES:
Figure 13.1 Effect of Incidental Life Insurance Benefit on Annual Contribution
Figure 13.2 Table 2001 One-Year Term Premiums for $1,000 of Life Insurance
Protection
Figure 13.3 Table 2001 Computation
CFP® CERTIFICATION EXAMINATION TOPIC:
Topic 66: Investment considerations for retirement plans
F. Life insurance
COMPETENCY:
Upon completion of this chapter, the student should be able to:
1. Have a basic understanding of using life insurance to fund a qualified
plan
Chapter 13
2. Understand ways in which life insurance may be used in defined
benefit plans
3. Understand ways in which life insurance may be used in defined
contribution plans
4. Identify key tax-related factors when using life insurance to fund a
qualified plan
KEY WORDS:
incidental test, combination plan, envelope funding, fully insured plan,
overfunding, Table 2001
DISCUSSION:
1. Discuss implications of using life insurance to fund a qualified plan
relative to the incidental death benefit test.
2. Discuss requirements for fully insured plans and how they may relate
to overfunding problems.
QUESTIONS:
1. The IRS has developed two tests for life insurance in a qualified plan
designed to determine whether the incidental benefit percentage is being met.
What is the maximum allowable percentage of the total cost of the plan
allowed for incidental benefits?
a.
b.
c.
d.
10
25
30
50
Chapter 13, p. 122
2. Which of the following are terms used to describe funding in a combination
plan?
(1) whole life policy
(2) side fund
(3) conversion fund
(4) envelope fund
Chapter 13
a.
b.
c.
d.
(1) only
(1) and (4) only
(1) (2) and (3) only
(2) (3) and (4) only
Chapter 13, p. 123
3. Which one of the following is true of fully insured plans (IRC Section 412(i)
plans)?
a.
b.
c.
d.
may be funded by a combination of life insurance and annuity contracts
premiums increase annually according to the participant’s current age
plan benefits may only exceed contract benefits by 125%
policy loans of less than 50% of plan assets with a maximum 10-year
repayment schedule may be allowed
Chapter 13, pp. 123-24
4. Which of the following correctly describe taxation of an insured death benefit
received by a beneficiary from a qualified plan?
(1) the pure insurance element is normally income tax free
(2) 100% of the benefit is distributed tax free
(3) non-death benefit distributions are taxed as qualified plan distributions
(4) Table 2001 costs paid by the participant may not be recovered tax free
a.
b.
c.
d.
(1) and (3) only
(1) (2) and (3) only
(2) (3) and (4) only
(1) (2) (3) and (4)
Chapter 13, pp. 125-27
ANSWERS:
1. b
2. c
3. a
4. a