As the stock market continues to slide, so does the average 401(k) account. Some 401(k) accounts have lost as much as 25% in value since the beginning of the year. That means that an account that had a $135,000 balance on January 1, 2022, is now worth about $101,000. This has left many plan participants wondering if they made a mistake participating in their 401(k) plan in the first place. Younger participants may be able to wait the market out until it recovers, but what about those who are close to retirement?
Business owners who are relying on 401(k) plans are in the same position as their employees. They are also wondering what to do about their own retirement plans.
There are other options for your retirement plans that most people are unaware of. This includes adding life insurance to your retirement plan. In this article we are going to discuss the benefits, why you should add it, and how to add it.
There are a number of benefits to adding life insurance to a retirement plan, including:
Life insurance can be used in both defined contribution and defined benefit plans. It must be offered on a uniform and nondiscriminatory basis. However, the Internal Revenue Code imposes certain limitations on the use of life insurance in qualified retirement plans.
There are two main types of retirement plans: defined contribution plans and defined benefit plans.
In a defined contribution plan, employees, and maybe their employer, make contributions to the plan. Each employee has their own account in the plan. How much money an employee will have at retirement will depend on the investment performance of their account.
Defined contribution plans include the traditional 401(k) plan and its relatives, the Roth 401(k) and the Safe Harbor 401(k).
In contrast, a defined benefit plan defines a participant’s final benefit based on a formula in the plan documents. The employer alone makes contributions to the plan. The employer must make annual contributions in an amount actuarially-determined to be sufficient to pay for the plan’s benefits.
Defined benefit plans include the traditional defined benefit plan and its relatives, the cash balance plan and the 412(e)(3) fully-insured plan.
A defined contribution plan can be funded with life insurance. However, the life insurance must be “incidental” to the plan’s main purpose of providing retirement benefits to the plan’s participants.
So, is there a limit on the amount of life insurance in a defined contribution plan? Yes, there is a limit on the amount of plan assets that can be used to pay insurance premiums. The amount that a plan can spend on insurance premiums depends upon the type of insurance policy:
Life insurance can be used in both traditional defined benefit plans and fully-insured 412(e)(3) plans. Unlike defined contribution plans, when life insurance is offered in a defined benefit plan, it must include all participants.
412(e)(3) plans are great for small business owners, especially those who are close to retirement or have not adequately provided for their retirement. They can be fully funded in a relatively short period of time. They generally require larger tax-deductible contributions. More importantly, they eliminate any market risk. The benefit is guaranteed by the insurance company, assuming all premiums have been timely paid. A business owner thereby transfers investment risk to the insurance company.
However, a 412(e)(3) plan must be done right and must meet all of the following six requirements:
A 412(e)(3) plan can be funded solely with annuity contracts or a combination of life insurance and annuity contracts. If life insurance is used in the plan, the life insurance is limited to an amount considered “incidental” to the plan’s main purpose, which is to provide retirement benefits to participants.
Life insurance can be used effectively in both defined contribution plans and defined benefit plans. It is especially appropriate in 412(e)(3) plans. However, using life insurance in any type of qualified retirement plan requires careful planning and an understanding of the rules regarding its use.
We, in the Pension Division of RMC Group, specialize in working with advisors who serve the small plan market and its participants. We can help you navigate the rules regarding the use of life insurance in a qualified retirement plan and help you market and explain to your business clients how life insurance in a qualified retirement plan, especially a 412(e)(3) defined benefit plan, can help them ensure sufficient and stable retirement income. With our help, you can shine by showing your clients the many benefits of including life insurance in their retirement planning.
Call 239-298-8210 or visit our website at rmcgp.com to see how we can partner with you to help your clients understand how funding their retirement with life insurance products can be beneficial.