Advisory Opinion 2006-03A

Dear Mr. Goldberg:

This is in response to your request for an advisory opinion concerning the applicability of Prohibited Transaction Exemption (PTE) 92-6, as amended,⁽¹⁾ to a transfer from an employee benefit plan of a second to die life insurance contract to the husband and wife whose lives are insured under the policy and who are both participants in the plan.

You presented the following facts in your submission. The plan involved is a tax-qualified profit sharing plan (the Plan). A participant is permitted, under the terms of the Plan, to direct the investment of his or her individual account into a life insurance policy on his or her life, or on the life of someone in whom the participant has an insurable interest. The policy at issue was purchased solely with funds from the husband's rollover account. In response to our questions, you confirmed that the Plan provides that participants have discretion with respect to investments in their rollover accounts.

The couple does not wish the Plan to retain the ownership of the second to die life insurance policy on their lives, nor do they wish the Plan to surrender it. They would like to jointly purchase this policy from the Plan for its cash surrender value (determined at the time of the sale) provided that such a transaction is not a prohibited transaction.

You have asked the following two questions relating to PTE 92-6:

1) Whether a second to die life insurance contract covering a husband and wife, would be deemed, for purposes of PTE 92-6, to be an individual life insurance policy?

2) Whether the sale by the Plan of the second to die life insurance policy jointly to a husband and wife who are both plan participants, for its cash surrender value would be deemed, for purposes of PTE 92-6, to "put the plan in the same cash position as it would have been had it retained the contract, surrendered it, and made any distribution owing to the participant on his vested interest under the plan?"

PTE 92-6 provides, in relevant part, that the restrictions of sections 406(a) and 406(b)(1) and (2) of the Employee Retirement Income Security Act of 1974 (ERISA) and the taxes imposed by section 4975(a) and (b) of the Internal Revenue Code of 1986 (the Code) by reason of section 4975(c)(1)(A) through (E) of the Code, shall not apply to the sale of an individual life insurance or annuity contract by an employee benefit plan to a participant provided that:

(a) Such participant is the insured under the contract;

(b)  the contract would, but for the sale, be surrendered by the plan;

(c)  the amount received by the plan as consideration for the sale is at least equal to the amount necessary to put the plan in the same cash position as it would have been had it retained the contract, surrendered it, and made any distribution owing to the participant on his vested interest under the plan;

​1)  In AO 98-07A (September 24, 1998), the Department opined that "to the extent that state law would permit an individual life insurance contract to cover the life of the participant and the participant's spouse, the Department would deem such a contract to be an individual life insurance contract for purposes of PTE 92-6."⁽²⁾ The same analysis would apply here. Here the policy covers two participants, who are husband and wife.

2)  The husband and wife seek to jointly purchase the second to die policy, under which they are both insured. This joint purchase meets the requirements of the class exemption because they both qualify as participants insured under the contract.

3)   The class exemption requires that "the contract would, but for the sale, be surrendered by the plan." In the preamble to the 2002 amendments to PTE 92-6,⁽³⁾ the Department confirmed that "if the participant has discretion and control of his/her account in the plan, and has exercised that authority, without being subject to undue influence, in accordance with plan provisions for individually directed investment of participant accounts, to sell a life insurance contract in compliance with the conditions of PTE 92-6, the requirement of condition I (3)(⁴⁾ would be satisfied." You represent that the husband has investment discretion with respect to the rollover account used to fund the policy and he desires to exercise that discretion to sell this policy to himself and his spouse in compliance with the conditions of PTE 92-6.

4)    PTE 92-6 requires that the amount received by the plan as consideration for the sale is at least equal to "the amount necessary to put the plan in the same cash position as it would have been had it retained the contract, surrendered it and made any distribution owing to the participant of his vested interest under the plan." You represent that the amount the husband and wife will pay is the cash surrender value. Assuming this amount is as much as the Plan could obtain if the policy was surrendered to the insurance company, the transaction will meet this condition of the class exemption.

As you are aware, the Internal Revenue Service recently amended its regulations pursuant to sec. 79, 83 and 402(a) of the Code to address distributions of life insurance and related products from qualified plans. These regulations provide that if a qualified plan transfers property to a plan participant or beneficiary in exchange for consideration that is less than the fair market value of the property, the transfer will be treated as a distribution by the plan to the participant to the extent the fair market value of the distributed property exceeds the amount received in exchange.⁽⁵⁾ As amended, if the fair market value of a life insurance policy is more than its cash surrender value, not only will this bargain element be subject to income tax in the year the policy is distributed but, as the Service explained in the preamble:⁽⁶⁾

any such bargain element is treated as a distribution under the plan for all other purposes of the Code, including the qualification requirements of section 401(a). Thus, for example, this bargain element is treated as a distribution for purposes of applying limitations on in-service distributions from certain qualified retirement plans and the limitations of section 415.

This amendment to the IRS regulations provides for different tax consequences than those described in the preamble to PTE 77-8,⁽⁷⁾ the predecessor of PTE 92-6. In this regard, it is the view of the Department that this amendment to the IRS regulations does not affect the relief described in PTE 92-6, or any of the conditions contained therein.

This letter constitutes an advisory opinion under ERISA Procedure 76-1 and is issued subject to the provisions of that procedure, including section 10, relating to the effects of an advisory opinion. We note that pursuant to section 5 of ERISA Procedure 76-1 this advisory opinion relates solely to the proposed transactions described in your letter.