Johnny Carson, one-time king of late night television, once quipped, “There’s only one fruitcake in the U.S. and it’s passed around from family to family.” The joke works because many don’t like fruit cake and, consequently, pass on any received to others at the next holiday season.
The fruit cake of the qualified plan world is the Table 2001. These are the IRS-issued rates to calculate the reportable economic benefit for life insurance coverage in a qualified plan. They are outrageously high so nobody uses them and they have been passed on for 14 years.
The good news is you don’t have to use them.
Insurance should be purchased from a carrier that has acceptable one-year non-renewable term rates that can be used as an alternative to Table 2001 in the economic benefit calculation.
These rates are “one-size-fits-all”, ignoring issues of gender, tobacco use or medical rating. Consequently, someone who needs high-cost coverage for their working life may be able to pay for the bulk of the premium with untaxed dollars inside a qualified plan.
In a recent case a 54-year-old male plan participant needed $1,000,000 coverage as income replacement protection until his intended retirement at age 65.
He was issued Standard smoker. He purchased 15-year level term to guarantee premiums until then, and maybe a couple years beyond if he decided to work longer. His premium was $10,334.
He chose to buy the coverage inside the plan. The carriers rates allowed him to report as income only $1,310 the first year. The rates increased each year with age, but even then by year 11 his reportable economic benefit was only $2,580.
In addition he has the option to distribute the policy at retirement (with its additional four years of level premiums plus conversion privileges). Distribution could be a taxable event depending on how the plan administrator determines the FMV of the policy.
Recall that term policies carry a reserve during the level premium period. Even then, in this case the participant anticipates almost $19,000 in basis (the accumulated economic benefits recognized) to assist in any tax liability occur if the policy is distributed.
But even this potential for tax leverage is not a magic bullet
A client must consider whether the tax savings is worth giving up the amount of the annual contribution to the plan that would have accumulated tax-deferred toward retirement. In addition, if there are possible estate tax concerns the proceeds will be includible in the taxable estate. The plan design must allow for use of life insurance.
The Georgia Fruit Cake Company and the Claxton Bakery are two of the largest makers of fruit cakes in the world. Their headquarters are located just a few blocks from each other in the small town of Claxton, GA (pop. 2,363). Together they produce over 2,000 tons of cake each year in small batches of 375 pounds.
Contact us with any questions concerning fruit cakes or the feasibility of life insurance in qualified plans and for information on carriers’ alternative term rates or calculation of anticipated economic benefits.