Rev. Rul. 73-501

Advice has been requested whether a profit-sharing plan which provides for a pre-retirement death benefit which consists of the life insurance proceeds plus the amount in the participant's account may qualify under section 401(a) of the Internal Revenue Code of 1954.

Under the plan provisions, less than 50 percent of the employer contributions credited to each participant's account are used to purchase ordinary life insurance policies on the participant's life. Upon reaching age 65, or upon prior termination of employment other than by death, the policies are converted into cash which is then distributed along with the employee's account balance in a lump sum. Upon the death of an employee prior to age 65, the amount credited to his account at that time, plus the face value of the insurance policies on his life, will be paid to his designated beneficiary as a pre-retirement death benefit.

Section 1.401-1(b)(1)(ii) of the Income Tax Regulations provides, in part, that a profit-sharing plan within the meaning of section 401 of the Code is primarily a plan of deferred compensation, but the amounts allocated to the account of a participant may be used to provide him or his family with incidental life insurance.

Under a qualified profit-sharing plan, the use of trust funds to pay the cost of life, accident, or health insurance for an employee is a distribution within the purview of section 402 of the Code. See Rev. Rul. 60-83, 1960-1 C.B. 157. Such distributions will be considered "incidental" within the meaning of section 1.401-1(b)(1)(ii) of the regulations if, in the aggregate, they do not exceed 25 percent of the current contributions, allocated to a participant's account, that have been accumulated less than two years to provide deferred benefits. In the case of ordinary life insurance policies, less than 50 percent of such contributions may be used to pay premiums since only approximately half of these premiums are used for pure insurance protection. Thus, the 50 percent limitation on the purchase of ordinary life insurance policies is consistent with the 25 percent limit on the cost of pure insurance protection. See Rev. Rul. 61-164, 1961-2 C.B. 99, and Rev. Rul. 66-143, 1966-1 C.B. 79.

The plan provisions in this case call for the participant's death beneficiary to receive the amounts accumulated for the participant during his lifetime, in addition to the proceeds from the ordinary life insurance policies purchased on his behalf. However, such distribution of the participant's account balance does not constitute a benefit that was derived from pure life insurance protection; rather, along with the reserve under the ordinary life insurance policies, it represents deferred compensation (plus interest earned thereon) accumulated for the participant during his lifetime. Furthermore, the 25 percent limit on the cost of pure insurance protection is not exceeded. Since upon the death of a participant the payment of his account balance represents a distribution of compensation deferred during his lifetime, and only incidental amounts are used to provide life insurance protection, the requirements of section 1.401-1(b)(1)(ii) of the regulations are satisfied.

Accordingly, this plan may qualify under section 401(a) of the Code. A contrary result, however, would be reached in a split funded pension plan where ordinary life insurance contracts are purchased providing a death benefit equal to 100 times the anticipated monthly normal retirement benefit and there is an additional death benefit payable from an auxiliary fund. See Rev. Rul. 68-453, 1968-2 C.B. 163.