Advanced Underwriting Consultants

Question of the Day – February 20

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client participates in a qualified plan, and it owns a policy insuring his life.  What options might the client have for having the policy transferred to personal ownership?

Answer: That depends in part on what the plan document says.  However, for most pension plans, the short answer is that he can buy it from the pension plan for its cash value (more technically, its PERC value), or, if he’s entitled to a distribution, take a taxable distribution of the policy.

Pension rules prohibit members of a family controlling 50% or more of the ownership of a business from buying a life insurance policy from the pension plan.  However, Prohibited Transaction Exemption  (PTE) 92-6 permits such an employee to purchase life insurance from the pension plan if the plan would have otherwise disposed of the policy.

Under PTE 92-6, as amended, the purchase price for the policy is its fair market value.

The IRS released Revenue Procedure 2005-25 saying the value of a life insurance contract sold or otherwise distributed from a qualified plan is the greater of its interpolated terminal reserve and its so-called PERC value.

Interpolated terminal reserve is the amount that the insurance company sets aside to fulfill its obligations under the policy.  In general, the interpolated reserve value of a life insurance contract is similar to its surrender value.

The calculation of the PERC value is a relatively new idea.  The Service set a safe harbor formula for determining the policy’s PERC value based on the aggregate of:

  • aggregate premiums paid; plus
  • any dividends, earnings or interest credited with respect to those premiums; minus
  • any distributions made; and minus
  • reasonable mortality charges and reasonable expense charges.

After purchasing the policy from the plan for its value, the participant would be free to re-configure policy ownership and beneficiary designation to meet his planning needs.  Of course, such re-configuration might have gift or other tax implications that would need to be managed.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – October 25

Ask the Experts!

Here’s the question of the day.

Question: How is a life insurance policy transferred from a business to an employee valued for income tax purposes?

Answer: Revenue Procedure 2005-25 created new rules for how life policies transferred in conjunction with employment are to be valued.  While the IRS did not create the final word on fair market value in 2005-25, it did provide a safe harbor method for calculating a policy’s value.

The safe harbor value of a life policy is the greater of

  • the interpolated terminal reserve plus unearned premium (ITR), or
  • the product of the PERC amount and the average surrender factor.

PERC stands for premium, expenses, and reasonable charges.  Stated simply, the PERC amount is premiums, plus dividends and other cash value earnings, minus actual mortality charges and other reasonable charges.  Any distributions taken from the contract prior to its valuation would also reduce the PERC value.  For most transfers related to employment, the PERC value is unadjusted by the policy’s surrender charges.

What is the PERC value of a life policy?  Generally speaking, it’s an amount approximately equal to the gross cash value for most universal life-style contracts.

As with gift tax transfers, we recommend that the policy owner start with his or her insurance agent to get a calculation for the ITR and PERC values for a life policy being transferred in connection with employment.  After those numbers are obtained, the clients should check with their own tax advisors to decide how to report the transaction for income tax purposes.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.