MoneyGuard From Life Insurance in Qualified Plans


Perhaps you have come across situations where a business owner is the insured life on a life policy held in a qualified plan. Let’s assume the participant’s need for the life insurance coverage has changed. The protection has been enjoyed by the insured for the annual cost of the tax based on the economic benefit rates but, for various reasons, there is discussion about canceling the policy. The annual economic benefit related administrative and tax costs may be annoying and/or burdensome. What do you tell the business owner?

  1. The plan can surrender the policy for cash.
  2. The participant-insured can purchase the policy from the plan with cash for fair market value (i.e. safe harbor PERC value Rev. Proc. 2005-25) and either reduce coverage or fully surrender the policy for cash. The fair market value might be equal to the cash surrender value, but not always.
  3. The participant-insured can take the policy out as a taxable plan distribution subject to the rules and limits. The tax on distribution can be offset somewhat by basis in the policy for previously reported economic benefit costs.

What other options might be available?

A. The Company Needs The Policy

The business owner’s closely-held corporation might need the policy to fund a stock redemption, to secure loans, to informally finance a nonqualified plan or for key person insurance reasons. It may even form the basis for a new type of executive benefit we’ll cover at the end of this page.

He could purchase the policy from the plan and change ownership (sell it) to the corporation. To come up with cash (the plan should get cash, not a note), the corporation could lend the him the money. The insured then purchases the policy with cash. Changing ownership to the corporation is a sale that should cancel the note. The plan has cash and the corporation has the policy.

As the insured is an officer and shareholder, it is not a transfer for value. And, there is a specific Department of Labor Prohibited Transaction Exemption (PTE 92-6) that permits the sale of an individual life insurance or annuity contract by an employee benefit plan to an employer, any of whose employees are covered by the plan.

B. The Business Owner Needs Long Term Care Insurance

If the insured business-owner needs long term care insurance, it may be possible to do a Section 1035 exchange for tax qualified long term care insurance and, being a linked benefit contract, MoneyGuard may be an ideal solution.

The insured could follow #2 or #3 above to obtain the policy and then, assuming the insured is insurable, do a 1035 exchange into MoneyGuard with the cash surrender value of the policy as the single premium. If the exchange amount alone does not produce enough of a long term care benefit, simply pay an additional amount in cash to solve for the desired long term care benefit amount.

Depending on the fair market value of the policy relative to the cash surrender value, possible distribution versus sale differences and the timing of the subsequent 1035 transaction, there may be little to no leverage. In other words, the FMV and CSV may be the same in some instances and it may not be any better than buying a MoneyGuard policy outright. If the policy is retained for a few years, perhaps at a reduced death benefit, the cash surrender value may continue to grow without additional premiums. Depending on the timing of the 1035 to MoneyGuard transaction, there may be some leverage. But, this clearly is not the most compelling method.

However, there may be a better way to take an unwanted life policy and turn it into a valuable long term care policy with the help of the owner’s business …

C. The Company Provides Long Term Care Insurance To Business Owner

Follow “method A” above to arrange for the sale of the policy to the company. Now that the company owns the policy, it can decide to do a 1035 exchange to MoneyGuard to create a new kind of executive benefit that provides long term care insurance protection plus valuable corporate benefits at the same time if the individual is insurable. The benefits are tax free reimbursements to the participant. Due to the guaranteed return of premium feature, it is balance sheet friendly. The value of tax-free death benefits and, potentially, significant tax deductions on long term care benefits, makes this very interesting for the corporation and its future owners.

Click here for details on how Corporate MoneyGuard can provide significant benefits now and in the future for both the business and the business owner.