Episode L focuses on life insurance, and the benefits of having life insurance as an investment in a plan. How much of the contribution can you use for insurance? Why would you want to use life insurance? We break it down for you, to give you the gist without being overwhelmed.
Episode L focuses on life insurance, and the benefits of having life insurance as an investment in a plan. How much of the contribution can you use for insurance? Why would you want to use life insurance? We break it down for you, to give you the gist without being overwhelmed.
This episode focuses on the letter L: Life Insurance. How does life insurance have anything to do with pension plans? One pays a benefit when you pass away, the other pays a benefit when you retire – hopefully for a long time! Well, they do come together, believe it or not. Is this legal? Can you use the whole thing for insurance? How does that all work? Let’s talk it through.
Episode L – Life Insurance in a QP First, how does life insurance have anything to do with a retirement plan? Usually you hear about insurance being paid for on an individual basis – you call up someone, go through a physical, give them a check every year, and you have insurance. Pretty simple. For a qualified retirement plan, there’s a business owner that makes contributions into a pension trust, the money needs to be solely for the benefit of the ptps, and when they quit or retire, the participants get their benefit. Two different things, right? Not necessarily.
· When the business owner contributes money for retirement benefits, that money needs to be invested in something. One option is life insurance.
· Note I said PART – there are limits to amts that can be used for ins, because it needs to be INCIDENTAL to the overall benefit. That means that no, can’t use all for LI. In a SEP or SIMPLE, can’t use any – these are IRAs, no LI allowed. In a PS or 401(k), can use up to 50%, dep on the type of ins. And in the big plans, the def ben, generally can use up to 40-45%, without tripping limits. Have to be careful w these, don’t want to trip limits and disqualify the plan, that would be bad. But if you have the chance to pay ins pre tax, why not?
· FUN FACT: First life ins co in US was the Friendly Society in 1735, established in Charleston SC.
· Let’s talk about why you’d put LI in a plan. Well, first is reason I mentioned-ability to pay prems pretax. Want to pay wholesale or retail? Gen wholesale – so if you can deduct life prems for you and your partners and key ees, good idea. Life ins can be critical to business planning – discussed more in Episode B – and ability to pay these prems pre-tax saves tax dollars that can go back into the business.
· Continuing down the taxation path – not only are the premiums paid pre-tax, but the death benefit paid to your bene in excess of the CV is also paid tax-free. What does this mean? Some types of ins have CV, which is a value that’s built up inside of the policy. It gets bigger year to year, and is counted as the ‘value’ of the policy when we’re figuring out what the ins is worth. Let’s say there’s an ins policy in the plan with $25k per year premiums, and a $500k death benefit. After 1 year, the cash value may be $15k. After 5 years, maybe $100k. What if you passed away in year 5 after 5 years of pretax prems? Cash value, value of the policy, stays in QP as qual plan asset, added to other investments, and will be distributed to your bene or estate. The 400k above that – 500k dth ben, 100k cv – passes through plan and paid to bene with no tax implications. One of few times paid for something pre tax and returned pre-tax. The bad news is that you passed away in order for this to happen …
· Other reason is that it provides preret death benefit from day 1. If you’re a biz owner, put plan in place to make up shortfall at ret – what happens if you pass away after 1 year? Spouse, bene have only 1 year of contribs, still way short. This way, if you pass away before ret, spouse/benes get death benefit. If not, you have the ret ben. Either way – you and your fam are set.
· Life ins policies are critical to estate and legacy planning. The SECURE Act legislation passed in Dec 2019 impacted IRAs to beneficiaries other than spouse – One way to preserve your legacy, and minimize taxes paid by you and your benes, is to have a qualified plan, and pay for insurance premiums with pretax dollars from a rollover. This is covered more in Episode S – it’s a great way to pair up life insurance and qualified plans to maximize what you leave to your heirs.
· FUN FACT: Speaking of maximizing … the largest life ins policy ever confirmed to be issued was $201M issued in 2014 to a silicon valley billionaire. However, there are rumors that there are a few policies around the $300M mark around …
· Another reason is the protection from creditors for any investments in the pension trust. If you have life policy in a plan, and there’s at least 1 rank and file ee (not related, not paid over 125k…), any assets in the plan are protected from bankruptcy. That means that if one of the investmts is a LI policy, that’s protected too, and creditors can’t get at it, period.
· Any add’l bens will attract top talent, because it will help your biz stand apart from the rest. Only 1/3 of small businesses offer any kind of QP – if you also offered life ins, it’s one extra feature that may be the tipping point for a key employee coming to work for you or going to work for someone else. Plus, since its in a QP, there will be vesting provisions, which means the EE has to stay with your biz for at least a few years in order to be elig to take the benefit. We’ll talk about that more in Episode V – Vesting and eligibility provisions.
· For employees, LI is great because the policy is theirs when they leave, if they want it and if they’re vested. They can change the ownership from the plan to themselves, take the life ins as a distribution, and they would retain all the rights and privileges of a policy holder. There are tax implications with the distribution, which are discussed in Episode D, but if they’re looking to have a policy for themselves, they can. They’d also be responsible for paying the prems, if there are addl prems to be paid, but there are ways that the policy can be changed so that there aren’t any more premiums (the death benefit will go down, but it’s possible)
· Last piece worth mentioning – some carriers will offer guaranteed issue insurance if there is a minimum number of people in the plan. What does this mean? What if you’re an owner and have 30 ees, and you’re not insurable? If you sponsor a qual plan and all the ees are in there, and you include life ins, you could get up to $200k of insurance at standard rates because of this GI program. If you had 55 ees, that amount goes up to $300k – the more EEs you have, the higher the guaranteed death benefit will be. See this when owners have insurability challenges, or family members. Need to do physicals and medicals for any amounts over this guar limit, but I’ve seen plans put in place because the owner needed ins, and this got him standard ratings.
· Some nay-sayers that don’t like LI in a plan – it’s a bad investment, some ins has fixed prems so it reduces flexibility, it adds an administrative burden because everyone in the plan needs to go through physicals … well, I agree with 2 of the 3! For some ins, fixed premius would reduce flex – but, if you have a DB plan, one of the bigger plans where contribs required anyways, doesn’t matter. And yes, may be like herding cats to do medicals for all ees – some ins carriers offer simplified issues of ins – unless red flag on some Qs, no medicals needed. As far as it being a bad inv? If you need ins, it’s a great inv – conservative, ded prems, market risk protection, guar bens for you and fam regardless, attract and retain.
· For our final fun fact, we’ll end with a question – would a transformer buy life insurance, or car insurance?
· Wrapping it all up – there are a lot of great reasons to use LI as an inv in a qualified plan, from tax savings to business planning to attracting and retaining employees. May not be able to get all of the ins you need in the plan, but even a part of it would help with all of these reasons. Not insurable? QP may be the only place you can get ins. Lots to consider, but if you need LI for anything, worth checking out whether a QP is the place to put it.
· Want to hear more? The other episodes mentioned here are B (Business planning), V (vesting), S (Stretch IRAs) and D (Distribs)
· Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.