Regulations Released to Shut Down Abuse in 412(i)s

February 13, 2004 (—The Treasury Department and Internal Revenue Service today issued guidelines, as promised, to shut down abusive transactions involving specially designed life insurance policies in retirement plans, according to a release.

>These plans have recurring abuses, which the IRS has designated “listed transactions” for tax-shelter reporting purposes.

“Again and again, we’ve uncovered abusive tax avoidance transactions that game the system to the detriment of those who play by the rules,” said IRS Commissioner Mark Everson, in the press release.

>The IRS describes a “section 412(i) plan” as a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.

>The guidance released today covers three specific abuses occurring within the plans, and details the proposed regulations:

  • The first set of proposed regulations specify that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value.   These regulations will be effective for transfers made on or after Friday, and the IRS says they will prevent taxpayers from using artificial devices to understate the value of the contract.   The proposed regulations also provide a temporary safe harbor for determining fair market value.   This regulation is designed to avoid the arrangements called the “springing value policies,” in which firms establish a section 412(i) plan and then, after deducting the contributions made to the plan, use them to purchase a specially designed life insurance contract. The insurance contract is designed so that the cash surrender value is significantly below the premiums paid, according to the IRS.   When this contract is then sold to the employee, the employee pays the depressed value, which suddenly “springs up” after the policy is transferred to the employee.   The “springing cash value” life insurance policy then allows employers to have tax deductions much greater than the income recognized by the employee.
  • The second revenue ruling says that an employer is not allowed to buy excessive life insurance in order to claim large tax deductions, an arrangement that will be a listed transaction for tax-shelter reporting purposes.   The IRS describes large life insurance contracts as those where the death benefits exceed the death benefits provided to the employee’s beneficiaries under the terms of the plan, with the balance of the proceeds reverting to the plan as a return on investment
  • The final ruling states that a section 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly paid employees, since many of the special policies have been made available only to the highly compensated employees.

The IRS news release is at,,id=120409,00.html .