What is it?

1. What is it? • Life insurance is purchased and owned by the qualified pension or profit sharing plan and uses employer contributions to the plan as a source of funds • When is the use of this technique indicated? • When a substantial number of employees under the plan have unmet insurance needs • When there are gaps or limitation in other company plans that provide death benefits • Group term plans • Split Dollar plans • Nonqualified deferred compensation plans • When a qualified plan for a closely held business or professional corporation is overfunded or close to the full funding limitation.

2. When is the use of this technique indicated? (cont'd) • When life insurance would be attractive to plan participants as an additional option for investing their plan accounts • When an employer wants an extremely secure funding vehicle for a plan with guarantees as to future costs and plan benefits • Plan proceeds can provide financial security for the participant’s survivors • Advantages • Premiums are deductible by the employer

3. Advantages (cont'd) • Life insurance inside a qualified plan • Lower premiums and higher dividends • “Locking in” present mortality standards • Life insurance with a built-in conversion into an annuity • No sales fees or other costs to purchase annuities • Pure insurance portion of the qualified plan death benefit not subject to income tax • A fully insured plan (412(i)) is not subject to the minimum funding requirements • Low cost installation and administration

4. Advantages (cont'd) • May be less expensive than group term insurance to the employee • May be less expensive than group term insurance to the employer • Greater amounts of life insurance for owner-employees than with group term • Substandard risks can obtain coverage that might otherwise not be available • Additional insurance premium ratings may be deductible to the employer • Substandard rating costs are not taxed to the employee • Death benefit risk transferred from the plan to the insurer

5. Advantages (cont'd) • Defined contribution plans • Employee can purchase insurance on the lives of certain relatives or even unrelated persons in whom they have an insurable interest • Funding a buy-sell agreement • Defined benefit plans • Life insurance may create a larger deduction, even in plans that are “maxed out” • Qualified plan can “incubate” a policy • High up front costs can be supported by the pension plan at the cost of reporting the economic benefit of the term insurance • Employee can obtain an individual life insurance contract at original issue age rates at retirement or termination of employment

6. Disadvantages • Insurance rate of return on cash values may be lower than alternative investments • Policy commissions and expenses may be higher than alterative investments • Income taxes are levied upon the death proceeds in an amount equal to the cash value portion of the policy immediately before the insured’s death • Exclusion of life insurance in a qualified plan from an insured’s estate is uncertain • What are the tax implications? • Employer contributions are deductible • The amount of life insurance purchased must fall within “incidental limits”

7. What are the tax implications? (cont'd) • Employer contributions are deductible (cont'd) • The “incidental” test • Cost of non-retirement benefit must be less than 25% of the total cost of the plan • Life insurance is considered “incidental" if • “100 to 1” test – the participant’s insured death benefit is not more than 100 times the expected monthly normal retirement benefit or • “Less than . . .” test – the aggregate premium paid over the life of the plan for any insured death benefit must at all times be less than • Ordinary life 50% • Term insurance 25% • Universal life 25% • Variable life 50%

8. What are the tax implications? (cont'd) • Employees can supplement the employer contributions with their own after-tax contributions • Coverage on key employees not subject to the incidental test to the extent that the proceeds are payable to the profit sharing plan and shared with all plan participants • The economic value of pure life insurance is taxed annually to the participant at the lower of • IRS Table 2001 or • The life insurance company’s actual rates for individual one-year term policies available to all standard risks

9. What are the tax implications? (cont'd) • Income taxation of an insured death benefit received by the beneficiary • Pure insurance element is income tax free to the participant’s beneficiary • The total of all Table 2001 costs paid by the participant can be recovered tax free from the death benefit • The sum of all nondeductible contributions toward the plan made by the employee is tax free to the participant’s beneficiary • Loans made by the plan and taxed to the employee are recovered tax free by the beneficiary • Any employer contributions that were, for some reason, taxed to the employee are tax free to the beneficiary

10. What are the tax implications? (cont'd) • Income taxation of an insured death benefit received by the beneficiary (cont'd) • The remainder of the distribution is taxed as a qualified plan distribution • The value of a life insurance contract sold or otherwise distributed from a plan is the contract’s cash value, without reduction for surrender charges provided that amount is at least as large as: • Premiums paid from date of issue through date of determination plus • Any amount credited with respect to those premiums (e.g. dividends and interest) or • With respect to variable life insurance • Adjustments made to premiums paid that reflect current market value and the current market value of segregated asset accounts • Minus reasonable mortality charges and other charges from date of issue to the date of distribution

11. What are the tax implications? (cont'd) • Qualified plan death benefits are, in general, included in the decedent’s estate for federal estate tax purposes.