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Case of the Week: Valuing Life Insurance Contracts Distributed from a 401(k) Plan

The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Texas is representative of a common inquiry regarding 401(k) plans and life insurance. The advisor asked:

“Is there any guidance on valuing a life insurance contract distributed from a 401(k) plan?”


  • Fortunately, there is. The IRS has provided safe harbor rules for determining the fair market value of life insurance contracts distributed from a qualified retirement plan in Revenue Procedure (Rev. Proc.) 2005-25.

  • Under Internal Revenue Code Section (IRC §) 402(a), amounts distributed to a plan participant, generally, are taxable in the year in which they are paid to the employee.

  • Treasury regulations provide that the cash value of any retirement income, endowment or other life insurance contract is includible in gross income at the time of the distribution [Treas. Reg. § 1.402(a)-1(a)(2)].

  • However, sometimes the stated cash surrender value of a contract does not accurately reflect its actual fair market value. In Rev. Proc. 2004-16, which was superseded by Rev. Proc. 2005-25, the IRS provides a formulaic approach to valuing a life insurance contract. The IRS issued the Revenue Procedures primarily to address the issue of a “springing cash value plan,” a policy in which, for the first few years, the cash surrender value of the policy is much lower than the value of the premiums paid or the reserve accumulations (Internal Revenue Manual 4.72.8.5.3).

  • Plan sponsors should ensure providers of life insurance contracts and plan record keepers are following the guidance of Rev. Proc. 2005-25 when determining the fair market value of a distributed life insurance contract.


Conclusion

Sometimes the stated cash surrender value of a life insurance contract does not accurately reflect its actual fair market value. Rev. Proc. 2005-25 provides a safe harbor means to calculate the fair market value of life insurance contracts.

The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.
Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.
Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.

©2016, Columbia Management Investment Advisers, LLC. Used with permission.

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