How to put an Indexed UL into a Qualified Plan

Upon the request of the employee participating in the plan, the plan trustee applies for the life insurance policy and is the policy owner. The participant names a beneficiary who will receive the pure insurance portion of the policy death benefit at the participant's death. The participant is taxed annually on the "economic benefit value" of the life insurance death benefit. At the employee's death the pure insurance portion of the death benefit is paid to the employee's beneficiary free of income taxes. The balance of the death benefit is paid to the trustee and added to the employee's qualified plan account. That plan account is paid out to the participant's designated beneficiaries on a taxable basis. The trustee should only purchase life insurance policies that use unisex rates.

In order for the plan to purchase a policy, it must meet the following three conditions.

1. The Qualified Plan Must Be Allowed to Purchase Life Insurance: Not all qualified plans have this privilege. For example, by law IRAs and Simplified Employee Pension Plans (SEPs) may not be able to purchase life insurance.
2. The Qualified Plan Must Specifically Permit the Trustee to Purchase Life Insurance: The qualified plan documents must give the trustee the specific power to purchase life insurance. If the plan document does not mention life insurance, it must be amended to include this provision before life insurance can be purchased.
3. The Amount of Life Insurance Purchased Must Not Exceed the Legal Limits: Congress established qualified plans for the primary purpose of helping employees accumulate funds for retirement. Life insurance benefits are allowed only so long as they are incidental to the retirement benefits. Incidental benefit rules have been established to make sure plan trustees retain the primary focus of providing retirement benefits. These rules limit how much of a participant's account can be used to pay life insurance premiums. The limit varies depending on the type of qualified plan:

Defined Benefit Plans: The life insurance coverage cannot be greater than 100 times the participant's projected monthly retirement benefit from the plan.

Defined Contribution Plans: In these types of plans, the premium must be less than 25 percent of the employer's total contributions to the plan for the employee.

Profit Sharing Plans: These are defined contribution plans with fewer limitations. For plans in effect for 5 years or more, any or all of the plan contributions and earnings can be used to pay policy premiums. For plans in effect for less than 5 years, only funds that have been in the plan for more than two years can be fully used to pay life insurance premiums. All other funds are restricted to 25 percent of the employer's total contributions to the plan for the employee. Because of their flexibility, profit sharing plans can be the best qualified pension plans for the purchase of life insurance.

There are some potential disadvantages that need to be discussed when purchasing life insurance in a qualified retirement plan:

1. The value of insurance for the pure death benefit is considered taxable income each year. This term insurance value is called the economic benefit. The employee's cost is the income tax on this economic benefit.
2. When the employee retires or changes jobs, the qualified plan may not be able to continue to own the life insurance policy. It may have to be surrendered or distributed to the employee.
3. If the employee dies, only part of the policy death benefits will be paid out to the employee's beneficiaries free of income taxes. A portion of the death benefit equal to the policy's cash value will be paid to the trustee and is fully taxable when it is distributed to the qualified plan beneficiary. The remainder of the death benefit (the net amount at risk) is paid out to the policy beneficiary income tax free.
4. The EIUL investment options may not perform as expected and policy cash values may not reach the level expected or illustrated. If this happens, the funds in the plan available for distribution in retirement may be reduced.