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, according to
final regulations issued by the Treasury Department and the IRS.
The regulations are aimed at shutting down abusive transactions involving "Section
412(i) plans" and similar arrangements. A Section 412(i) plan is a tax-qualified
retirement plan funded solely by a life insurance contract or an annuity. An
employer deducts contributions used to pay premiums. 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 (e.g., upon retirement).
Under abusive arrangements, the cash surrender value is temporarily depressed
to a level far below the premiums paid. The contract is structured so that the
cash surrender value increases significantly once the contract is transferred
to the employee, creating a mismatch between the employer's deduction and
the employee's recognition of income, according to the Treasury.
The regulations are effective for transfers made on or after February 13, 2004.