Surrender 1987 Ok.ru

[Sabel Kantah]

Aparticpant wants to surrender their insurance in the Plan and transfer the cash value into their account in other assets. The participant is 40 years old and still employeed. The CV is $10,000. The PS-58 costs (basis) are $1,000. The Plan does not allow for after tax contributions. What happens? How do they account for the 9k pre-tax and 1k after-tax? Is this a document issue?

Ok, so I now know you lose the ability to recapture the ps-58 cost if the policy is not distributed to the participant. Does the full 10k still get transferred to the other assets in the Plan? i.e. the participant will end up paying tax twice on the 1,000 (ps-58 cost)?

FWIW, I wouldn't be so sure the basis is lost. Opinions are on both sides of the fence on this - some say yes, some say no. PLR 8721083 (not positive about that number) provided that the basis is retained. And, this is certainly the common sense approach. Which approach you choose may be based upon advice of counsel, risk/reward analysis, and amount involved. For $1,000, most I've seen would consider it basis upon subsequent distribution.

1. The cash value is not a rollover. It belongs to whatever source of money was used to pay the premium. For this purpose (moving it from the insurance company to current investments) just pretend it's in mutual fund A. There's really no difference.

2. The PS 58 costs (now I think called Table 1 costs) are the amount an insured reports as taxable income every year because they receive a current benefit from the insurance coverage. If the participant dies and the plan pays out the death benefit, the beneficiary may treat the reports costs as a basis in the payout and reduce the taxable amount. If the participant surrenders the policy, the taxable basis is lost and is not recovered.

You may find this both interesting and helpful. Granted that a PLR cannot be cited as precedent, the IRS has essentially followed this line of thinking in any situation I'm aware of. But I'd pass the buck to the client's ERISA counsel.

This is in response to a ruling request dated April 17, 1985, as supplemented by a letter dated December 16, 1985, and a telephone conversation on February 3, 1987, submitted on your behalf by your authorized representative concerning the federal income tax consequences of distributions from Plan X.

1. That the entire employee benefit arrangement between the employee/participant and Company M as the trustee and plan administrator embodied in Plan X consisting of the various programs and deductions, contributions, and payments pursuant to Plan X is a single contract for federal tax purposes.

4. That in completing a Form 1099 for any year in which there was any distribution from Plan X with regard to a participant who was previously taxed on a portion of such distribution as P.S. 58 costs, the trustee of Plan X shall not include the portion attributable to such P.S. 58 costs in the amount of the distribution from Plan X taxable to the recipient but rather shall indicate that such portion is a tax-free return of investment in the contract.

Section 1.72-2(a)(3)(i) of the Income Tax Regulations provides that for the purposes of applying section 72 of the Code to distributions and payments from qualified plans, each separate program of the employer consisting of interrelated contributions and benefits shall be considered a single contract. Section 1.72 - 2(a)(3)(ii) of the regulations lists the following types of benefits and the contributions used to provide them, as examples of separate programs of interrelated contributions and benefits:

The regulation, however, states that retirement benefits and life insurance will be considered part of a single, separate program of interrelated contributions and benefits to the extent they are provided under retirement income, endowment or other contracts providing life insurance protection.

Example (7) of section 1.72-2(a)(3) (iv) of the regulations describes a situation in which a plan provided both retirement and death benefits through the purchase of individual retirement income contracts from an insurance company. Any distribution received by an employee under such a plan, whether attributable to one or more retirement income contracts and whether made directly from an insurance company to the employee or made through the trustee shall be considered as received under a single contract for the purposes of section 72 of the Code.

The facts of Example (8) of section 1.72-2(a)(3) (iv) of the regulations are similar to those with regard to Plan X prior to its 1978 amendment and change in funding method. In Example (8), the plan funded the death benefits and part of the retirement benefits by purchasing individual retirement contracts from an insurance company. The remaining part of the retirement benefits are to be paid out of a separate investment fund. Accordingly, the pension plan includes, with respect to each participant, two separate contracts for purposes of section 72 of the Code. The retirement income contract purchased by the trust for each participant is a separate program of interrelated contributions and benefits and all distributions attributable to such contact (whether made directly from the insurance company to the employee or made through the trustee) are considered as received under a single contract.

Accordingly, with respect to your first ruling request, we conclude that the entire employee benefit arrangement of interrelated contributions and benefits between the employee/participant and Company M as the trustee and plan administrator embodied in Plan X after the redemption of the whole life policies is a single contract for purposes of section 72 of the Code. However, please note that in conformity with Example 8 of section 1.72-2(a)(3) (iv) of the regulations, all benefits and distributions attributable to the redeemed whole life policies are, for purposes of section 72 , considered as received under a single contract.

Section 72(b)(1) of the Code provides, in part, that gross income does not include that part of any amount received as an annuity which bears the same ratio to such amount as the investment in the contract bears to the expected return under the contract.

Section 72(m)(3) of the Code provides, in part, that any deductible contribution to a trust described in section 401(a) and exempt from tax under section 501(a) , which has been used to purchase life insurance protection for a participant is includible in the gross income of the participant for the appropriate taxable year.

Section 1.72-16(b)(4) of the regulations, dealing with the treatment of the cost of life insurance protection, however, provides that the amount includible in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of section 1.72 - 2(a)(3)) providing the life insurance protection.

4. In completing Form 1099 for any year in which there is any distribution from Plan X with regard to a participant who was previously taxed on such portion of the distribution as P.S. 58 costs, the trustee shall indicate that such portion is a tax-free return of investment in the contract.

Please note that for purposes of the conclusions reached in ruling requests 3 and 4, section 1122 of the Tax Reform Act of 1986 has amended section 72(b) of the Code so that an individual whose annuity starting date is before January 1, 1987, must exclude the same percentage of each distribution from taxation no matter for how long annuity payments are received. An individual with a later annuity starting date, however, must stop excluding a portion of the distribution from taxation when the individual has recovered tax-free the actual amount of employee contributions.

This ruling is based upon the assumption that Plan X was and will be qualified under section 401(a) of the Code and its related trust was and will be exempt from tax under section 501 (a) at all time relevant to this ruling request.

Belgarath, thanks for that. I actually now remember seeing that PLR when it came out. My fuzzy recollection is that there were differences between the recovery if the policy or "contract" was surrendered to pay the benefit (no recovery) or if the policy or "contract" was annuitized to pay the benefit (recovery).

fwiw, I don't think it was fully answered - you don't want a separate after-tax account. It's part of the "regular" money but it simply has basis and you show that as non-taxable (and non-rollable) at the time of eventual payout (unless you just ignore the basis entirely...I'd show it though, based on the PLR cited).

This publication discusses the tax treatment of distributions you receive from pension and annuity plans and also shows you how to report the income on your federal income tax return. How these distributions are taxed depends on whether they are periodic payments (amounts received as an annuity) that are paid at regular intervals over several years or nonperiodic payments (amounts not received as an annuity).

How to figure the tax-free part of nonperiodic payments from qualified and nonqualified plans, and how to use the optional methods to figure the tax on lump-sum distributions from pension, stock bonus, and profit-sharing plans.

If you are retired from the federal government (regular, phased, or disability retirement) or are the survivor or beneficiary of a federal employee or retiree who died, see Pub. 721, Tax Guide to U.S. Civil Service Retirement Benefits. Pub. 721 covers the tax treatment of federal retirement benefits, primarily those paid under the Civil Service Retirement System (CSRS) or the Federal Employees' Retirement System (FERS). It also covers benefits paid from the Thrift Savings Plan (TSP).

For information about the tax treatment of these benefits, see Pub. 915, Social Security and Equivalent Railroad Retirement Benefits. However, this publication (575) covers the tax treatment of the non-social security equivalent benefit portion of tier 1 railroad retirement benefits, tier 2 benefits, vested dual benefits, and supplemental annuity benefits paid by the U.S. Railroad Retirement Board.

3a8082e126