Life insurance as a funding vehicle for qualified plans

Any qualified plan may purchase life insurance so long as life insurance does not represent the primary focus of the plan, but rather represents an incidental death benefit for beneficiaries. While life insurance proceeds are generally not taxable to beneficiaries, life insurance proceeds to the extent of cash values for policies purchased inside of qualified plans are taxable as ordinary income to beneficiaries. Employer paid premiums for policies purchased inside of qualified plans are taxable at the time of premium payment as ordinary income to benefiting employees based on imputed annual term life insurance premiums derived from IRS Table 2001 (notably, this creates taxable basis). Life insurance purchased inside of qualified plans must remain an incidental death benefit in order for plans to retain their qualified status; this may be determined by the “25 percent test” or the “100 to 1 ratio test”, which consequently limits the amount or cost of life insurance coverage that may be provided within qualified plans.