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Retirement Plans Are For Retirement, Not Estate Planning
By Marc J. Lane

Some financial advisors have seen merit in buying life insurance out of one's pension plan, using tax-deductible dollars to pay the premiums. We've never been great fans of this strategy, arguing instead that a pension presents an extraordinary opportunity to grow wealth on a tax-favored basis. To the extent pension dollars are diverted to fund insurance costs, total investment returns are diluted and the pension's very purpose is compromised.

Now, two senior IRS officials have publicly raised serious questions about the legality of a pension's purchase of life insurance, in this case a 'second-to-die' policy on the lives of an employee-participant and his wife. The officials insist - as we have long held - that a pension plan is designed to provide retirement benefits. It's not to be used as an estate planning vehicle. Thus, the purchase of insurance, particularly on the life of someone other than the employee (here, his wife), violates a fundamental requirement for such plans. What's more, we've learned that the IRS position, as it is evolving, would similarly extend to profit-sharing plans.

The IRS officials, in taking their stand, have relied on the "exclusive benefit rule," which requires that tax-qualified plans be maintained for the exclusive benefit of employees. They reason that maintaining life insurance on someone other than an employee runs afoul of that mandate.

There's another problem, too. IRS regs require that a pension plan primarily provide systematically for the payment of "definitely determinable" benefits to employees over a period of years after retirement, typically for life. Although the Service has long allowed pensions to offer incidental death benefits which can be funded by life insurance, the IRS, citing a 30-year-old ruling, now seems to hold that maintaining life insurance on an individual other than an employee fails to satisfy the "definitely determinable" standard.

The new IRS position is not without controversy. After all, many retirement plans permitting the purchase of second-to-die policies have already received favorable determination letters from the Service.

The officials' comments were in fact occasioned by a pending ruling request before the IRS. As it now appears, that ruling may be issued in adverse form - or the request may be voluntarily withdrawn by the taxpayer.

What seems clear is that the issue won't go away. So those who are considering a second-to-die purchase with retirement plan money should explore the alternatives. And those whose plans have already made such purchases would be well advised to seek counsel.

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Marc Lane is a business and tax attorney, a Master Registered Financial Planner, a Registered Financial Consultant, and a Certified Investment Specialist. He is an Adjunct Professor of Law at Northwestern University and an Adjunct Professor of Business at the University of Illinois. He is the author of 30 books on business organization, taxation, and personal finance. His newest book, "Advising Entrepreneurs: Dynamic Strategies for Financial Growth" draws from his experience working with those who have successfully built their businesses.

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