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  • Is a policy inside a qualified retirement a good idea?
  • August 8, 2013
  • Tony Steuer

    By Tony Steuer, CLU, LA

    Qualified retirement plans are designed to encourage employees to save money, so that they will have enough when they are no longer working. In simpler terms, this type of plan is a tax-favored accumulation vehicle like permanent (cash value) life insurance.

    However, paying life insurance and annuity premiums with qualified-plan dollars is quite controversial. Why put an accumulation vehicle that enjoys tax-deferred treatment inside a plan that, by definition, is tax deferred?

    Every situation is different; some may benefit from a plan life this while others may not.

    A good place to start is by looking at a 403(b) plan, which is a tax-deferred retirement plan for employers of school and other nonprofit organizations. These plans are also known as tax-sheltered annuities, even though the term includes mutual funds and “incidental” life insurance.

    Consult with your insurance adviser before getting a life insurance policy inside a qualified retirement plan.

    The rules for selling life insurance inside a 403(b) plan are fairly loose.

    A participant can use up to 50% of the aggregate contributions made to a 403(b) plan to purchase whole life insurance. In the case of universal life insurance, only 25% of the aggregate contributions can be used to purchase a policy.

    For example, consider that a tax-sheltered annuity participant has accumulated $100,000.

    Then suppose a producer persuades the participant to use $49,000 to pay for a whole life insurance policy.

    The result – life insurance sales charges and other expenses eat up a lot of participant dollars, which otherwise could be growing toward a retirement fund. Also, there is no question that this sale earned the producer a nice commission.

    Arguments that favor buying life insurance with qualified-plan dollars:

    · The life insurance is purchased with pretax dollars

    · The life insurance provides a self-completing financial and/or estate plan.

    · The participant may keep the policy after retirement (by paying income tax on the cash value).

    · Premiums can be paid from previously accumulated contributions.

    · If no longer needed, the life insurance cash value can be transferred to an annuity contract.

    · The participant can borrow the cash value subject to Internal Revenue Service Code Sec. 72(p) rules.

    · The life insurance company calculates the annual cost of insurance that must be included in the participant’s taxable income.

    Arguments against buying life insurance with qualified-plan dollars:

    · It is more of a commission-driven than a need-oriented sale.

    · The mortality charge introduced an additional cost element when compared with an annuity or mutual fund. (Annuities on which the surrender charge is waived upon death contain a mortality element, but it is small enough to ignore for our purposes.)

    · It is an attempt to fill a permanent need with temporary coverage. The life insurance policy must be distributed by the plan at retirement and income tax paid on it, or it must be converted to an annuity payout or surrendered.

    · Income tax must be paid each year on the current cost of the “incidental” life insurance element.

    · It uses up the participant’s 403(b) contribution limit – called the exclusion allowance.

    · All other things being equal, a lot less money will be accumulated when life insurance is used as the accumulation vehicle.

About Tony Steuer

Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.

Creative Commons License
Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.

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