Rev. Rul. 60-83

Advice has been requested whether the trust forming a part of an employees' profit-sharing plan will continue to qualify under section 401(a) for exemption from tax under section 501(a) of the Internal Revenue Code of 1954 if current contributions to the trust funds are used to purchase paid-up units of endowment insurance on behalf of the employee participants.

Under the provisions of an employees' profit-sharing plan, the employer's contributions to the trust, forming a part of the plan, will be allocated to participants in accordance with the formula set forth in the plan. Such funds will then be used to purchase units of paid-up endowment insurance for the participants. Upon retirement, that total value of all the units of endowment insurance purchased will be used to pay the participant retirement income in the form of life annuities; in the event of his death before retirement, an equivalent amount will be paid to his beneficiary.

A trust forming a part of an employees' profit-sharing plan having once established its qualification under section 401(a) of the code may subsequently lose its exemption from tax under section 501(a) of the Code, if distribution of its funds are made in a prohibited manner. The use of trust funds for the cost of current benefits, such as life insurance protection for the benefit of an employee or his beneficiaries, constitutes a distribution within the meaning of the Code. See section 1.402(a)-1(a)(3) of the Income Tax Regulations. An employees' pension, profit-sharing or stock bonus plan, intended to qualify under section 401(a) of the Code, must provide primarily for benefits the distribution of which is deferred. See section 1.401-1(b)(1) of the regulations.

However, the distribution of all or a greater part of the trust funds under a profit-sharing plan may properly be made after the funds have been held or accumulated after a `fixed number of years.' The term `fixed number of years' is considered to mean at least two years. Rev. Rul. 54-231, C.B. 1954-1, 150. A current distribution of trust funds, before accumulation for a fixed number of years, will cause a qualified trust to lose its tax-exempt status. Therefore, the purchase of life insurance with trust funds properly accumulated under a profit-sharing plan for two or more years is a distribution which will not disqualify a profit-sharing plan.

Life insurance protection may be purchased with current contributions of a profit-sharing plan where the amount invested is incidental or subordinate to the primary purpose of the plan which is to permit the employees or their beneficiaries to participate in a plan of deferred compensation. See section 1.401-1(b)(1)(ii) of the regulations.

Revenue Ruling 54-51, C.B. 1954-1, 147, states that an investment of a profit-sharing trust in an ordinary life insurance contract for the purpose of providing death benefits for each insurable participant under the trust, will be considered incidental and subordinate to the primary purpose of a qualified profit-sharing plan where (1) the aggregate premiums for life insurance in the case of each participant is less than one-half of the aggregate of the contributions allocated to him at any particular time and (2) the plan requires the trustee to convert the entire value of the life insurance contract at or before retirement into cash or to provide periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement. See also Rev. Rul. 57-213, C.B. 1957-1, 157.

In the case of Raymond J. Moore, et al v. Commissioner , 45 B.T.A. 1073, acquiescence, C.B. 1944, 20, the issue involved was whether an employee's pension plan could qualify if, in addition to pension benefits, it provided life insurance protection under the terms of the insurance company's policies used to fund the pension. It was held that the mere fact that the policies, under which the pension benefits were funded, incidentally provided life insurance protection, did not cause the plan to fail of qualification as a pension plan. The initial life insurance protection provided under the policies in that case equalled 100 times the monthly annuity. Thus, in a level premium retirement income contract providing for the accumulation of a fund sufficient to pay a life annuity of $10 per month upon attainment of age 65 years, with a death benefit before retirement equal to $1,000 (for each $10 of retirement income) or the cash value if greater, the life insurance element is considered `incidental' to the purpose of accumulating funds for distribution at retirement age, and purchase of such contracts under a profit-sharing plan is acceptable.

In determining whether a particular case complies with the above stated principles, it is necessary to determine the approximate proportion of the over-all cost of the program which is not accumulated for payment of deferred benefits.

In the Moore case, supra , the premiums on the policies were paid on a level premium basis. There, during the early part of the period of years extending from date of issue of the policies to their maturity date, proportionately large parts of the premiums are applied to provide the life insurance protection, which represents the difference between the face amount of the policy (which becomes payable in case of death) and the reserve. See also Rev. Rul. 54-67, C.B. 1954-1, 1949.

In cases where the benefits are provided by the purchase of single premium or `paid up' endowment policies, such as in the instant case, there is an immediate provision for a large portion of the reserve necessary to provide the deferred benefit payable at maturity, if the insured shall survive. The balance of such reserve accumulation is provided by the increase thereof in the hands of the insurer. Therefore, the difference between the reserve and the face amount of the policy, that is, the net amount of insurance payable in the event of the insured's death, is initially much less than in the case where level premium payments are made.

Also, the average net amount of insurance for all years prior to retirement in such paid-up endowment policies is not significantly different from the average net amount of insurance under an acceptable level premium policy which satisfies the `100 to 1' rule.

Accordingly, it is held that the investment of current contributions under a profit-sharing plan in insurance protection by the purchase of paid up units of endowment insurance, as in the instant case, where, upon retirement, the total value of all units of such insurance purchased will be used to pay to the participant retirement income in the form of monthly annuities, will be allowed under a qualified plan. The life insurance element, in such policies, is incidental to the primary purpose of the plan, which is to permit the employees or their beneficiaries to participate in a plan of deferred benefits.