Paying Life Insurance Premiums with Pre-tax Dollars Via 401k

Have any of you done this? or know about this?
I guess you have to amend the TPA agreement for two provisions?

Kinda used for exit planning where the owner doesn't see his 401k making his retirement but the sale of his business will, via the use of 401k dollars to purchase life insurance.

Looking for direction from the usual pros:
Brandon
Larry
Tyler
David
 
I haven't sold qualified plans in a long time, but the deductibility of the premiums would obviously have a negative effect on the cash value and death benefit.
 
Would you rather pay taxes on the seeds or the harvest?

To net the amount of death benefit needed, you'd have to 'gross-up' the premiums by about 30% (or whatever tax bracket the owner is in).

There Ain't No Such Thing As A Free Lunch.

I wouldn't spend much time (if any) trying to find a tax-deductible method of purchasing life insurance.
 
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Outside of health insurance (for now) there is no double sided tax advantage to benefits that allows tax deduction with no "income" consequence later.

If you want your premium "tax free" are you prepared to pay taxes on the benefit?
 
Actually there are some very beneficial strategies to placing LI in a 401k.

I dont exactly have time to go too much into detail.

But long story short:
-Premiums are deductible

-DB is split between the bene and the plan. Basis goes to plan. Any DB over basis goes to the bene income tax-free. The DB that goes to the plan is tax-free to the plan, but still subject to taxation upon distribution just like normal plan assets.

-No more than 25% of yearly contributions can be used to pay premiums. No more than 25% of assets under 2 years old can be used to pay premiums. Usually, 100% of assets over 2 years old can be used to pay premiums.

-The COI is taxable as income on a yearly basis

-Also, the policy can be rolled out of the plan at the Surrender Value. So using a high surrender UL you can deduct premiums and roll out at possibly a significant discount.


Obviously this is a tax/estate technique.


Technically the trustee of the plan purchases and owns the policy for the participant. So the insured must be the participant.
And the Plan Documents must allow for the plan to accept LI. Since it is usually the owner of the business who is doing this, it usually isnt hard to amend the plan docs if they use a TPA for the plan.


For the right situation it can be very beneficial.

Life Insurance can also be used to fund pension plans. That is done more often than 401Ks probably.
 
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Back in "olden times" we put WL in defined contribution plans up to 50% of the contribution and later UL up to 25%. If life insurance is in a qualified plan, fine... but it is not even close in functionality to permanent LI outside of a QP.
 
Back in "olden times" we put WL in defined contribution plans up to 50% of the contribution and later UL up to 25%. If life insurance is in a qualified plan, fine... but it is not even close in functionality to permanent LI outside of a QP.

Its all abut perspective and need. It isnt the same, but for the right situation it could be better.

And funding a 401k with LI is different than a Pension.


And the roll-out strategy actually gives you a regular individually owned LI policy.
Often you can roll out of the plan for around 40%-60% of premiums paid.
So you get pre-tax premiums (for most people that means about 40% more than they could contribute after taxes). Then you only get taxed on around half of those premiums.


Its also a great strategy for business owners who plan to leave part of their 401k as inheritance. It significantly increases the inheritance. No reason not to if that is the persons plan.
 
As a general rule; if the premium is after tax, the DB is tax free. If the premium is pre-tax, the DB is taxable. But, there are several more or less complicated ways to change that. So, if you pay with pre-tax money, you have to take some action on the DB end to keep it tax free.
 
I saw this on Lifehealthpro, didn't know if anyone was familiar with this...

Exit planning: All questions answered | LifeHealthPro

Question #3: In the [January Life Insurance Selling Producer Roundtable] article, you mentioned using 401(k) to fund the buy-sell life plan. Can you please elaborate on that? – Raymond L.

E. Dennis Zahrbock: Yes, we bring this up in all cases and in about 1 in 10 it is chosen. A Profit Sharing Plan (which must be the foundation for a 401(k) Plan) may allow a participant to purchase insurance on anyone in which they have an insurable interest. Thus, one owner may purchase insurance on another owner (insurable interest) with his plan paying the premium. This may be term, UL, VUL, or WL. One-hundred percent of the participant’s account may be used to fund life insurance if the money is at least two years old OR the individual has been a participant for 5 years. What must be done to allow this transaction is an amendment to the plan to have these two provisions. Most plans in the USA use the same document providing service and both of these are standard provisions but they are seldom elected by the TPA that handles the plan. My guess is because they, themselves, don’t understand their benefits. All that needs to be done is to explain that they are available, and “presto” you can use plan dollars for premiums. You do have PS-58 (now called Table I) charges. When we find it used is the case where cash flow is tight and the owners feel their Profit Sharing/401(k) is not their retirement while their business ownership will be. In our company, both of my partners own insurance on me via our Company Profit Sharing/401(k). It’s simply a convenient place to pay the premium with pre-tax money. The DB remains income tax-free because of the PS-58 rules.
 
I saw this on Lifehealthpro, didn't know if anyone was familiar with this...

Exit planning: All questions answered | LifeHealthPro


Its funny, I have been told/read different things involving who the insured can be on 401k owned LI. A trusted TPA told me that it could only be on the participant. But I have read from multiple sources that it can be on anyone. Then other sources have said it can be on any participant. Im wondering if this is one of those ERISA grey areas...


The buy/sell setup works nicely.

But just a simple estate play works well.
Lets say you do a simple $500k, 15 pay GUL:

It takes $179k in Premiums

Normally, if LI wasnt used, that $179k would pass to the spouse & would be worth around $107k after tax.

But if you used that $179k to buy LI, it creates a $500k DB.

At death, $179k (basis) goes back to the 401k & is treated as normal qualified money. So like the "doing nothing" example, it is effectively worth $107k after tax.
The remaining $321k goes to the spouse income tax-free. Thats a net of $428k.

No LI in plan- $107k to spouse
LI in plan- $428k to spouse


So if part of the plan (or the whole plan) is earmarked as inheritance, it just makes sense to do.


So now lets compare using pre-tax dollars vs. after-tax dollars

Pre-Tax we already know; $179k premiums/$428k net DB

After-Tax it would take about $298k in Income to have $179k in after-tax Premium. (assuming a 40% tax bracket)

Results:
After tax: $298k in total Income spent - $500k DB
Pre-Tax: $179k in total Income spent - $428k DB

So using pretax dollars gives you an extra $123k in income, and only $72k less in DB.





Another option (assuming anyone can be insured) would be to use an overfunded SIUL.

The spouses can access the CV while alive. The policy gets better performance being survivorship. And the kids get a much larger inheritance utilizing the DB.
 
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