13 August 2012 0 Comments

Does Life Insurance Have A Place In Qualified Retirement Plans?

There are two basic types of tax qualified retirement plans:  Defined Contribution (DC) and Defined Benefit (DB).  Profit Sharing and 401(k) plans fall into the DC category and Pensions fall into the DB area.

With a DC plan the value of your account at retirement will depend on how much has been deposited and the performance of the investments made during your working years.  With one exception, I do not advise that life insurance be used as an investment option in a DC plan.  There are three reasons for this:

  • The living benefits of life insurance will not produce as much cash at retirement as comparable deposits into an investment account.
  • Taxes will be assessed currently for the death benefit provided by life insurance in qualified plans.  With Term it will be the actual premium and with cash value policies it will be based on an IRC table (PS58 rates).
  • At retirement, or when you otherwise leave your employment, if you want to continue the life insurance policy you cannot roll it into an IRA.  You will need to remove the policy from the plan, pay income tax on its cash value and continue to pay premium with after tax dollars.

So, what’s the exception?  When might you want to opt for life insurance inside a DC plan?  If you cannot obtain insurance individually, or it is highly rated, and insurance in the plan is guaranteed to be issued at affordable premiums, you will want to take advantage of this if insurance protection is called for.

Life Insurance is used more frequently in DB plans.  If you are in a DB Pension Plan you won’t have a say as to include Life Insurance or not.  In small businesses or professions the owner usually establishes this type of plan because it favors the older, more highly compensated employees—namely him.  Or, if you are the owner—you.  Placing life insurance inside the plan increases the cost, but since it is a tax deductible expense and the preponderance of this cost inures to the benefit of the owner, he might consider this to be an advantageous way to provide personal life insurance.  Business owners, however, must be aware that the 2nd and 3rd points above still apply here.  If business owners need insurance only until retirement, then term purchased outside the plan is a better way to go.  If they will need it after retirement, the cost of removing the policy after retirement can be very expensive and purchasing a permanent plan outside of the qualified plan, makes a great deal of sense.

In general, purchasing life insurance outside of qualified plans—be it term or permanent—provides for personal control of this important protection, while enhancing retirement benefits.

Coming up, I’ll be giving you my personal thoughts about life insurance on children.

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