Tax Issues concerning Life Insurance in Retirement Plans?

Adding life insurance to a retirement plan is a time-honored strategy for a Plan to provide enhanced survivor benefits on a tax-favored basis.

1. The Plan Documents must permit the purchase of life insurance.

2. Some profit sharing plans, a Plan has “aged” money, the amount of premium allocable to life insurance must satisfy the “incidental benefit test”

3. Usually, life insurance death proceeds are includable in an insured’s estate for estate tax purposes.

4. Life insurance coverage cannot continue inside the plan after the participant’s termination.

5. The cost of life insurance protection (commonly referred to as “PS 58” cost) provided under the Plan must be included in the employee’s gross income for the tax year in which deductible employer contributions or trust income is used to purchase life insurance protection.

6. A beneficiary pays income tax on life insurance death proceeds equal to cash value just prior to death, minus the sum of the PS58 costs of life insurance protection previously taxed to the employee. However, if the deceased was an owner-employee, the previously taxed PS58 costs cannot be subtracted.