Life Insurance and 403(b) Tax-Sheltered Annuities

• The IRS ruled that a provision in a "403(b)" tax-sheltered annuity giving church employees the option of purchasing a life insurance contract with a portion of their annual contributions does not adversely affect the continued qualification of the 403(b) annuity plan. A church adopted a 403(b) retirement program for its employees. The arrangement permits employees to elect to use part of their annual contributions under the arrangement to pay premiums on life insurance. This option is provided as part of the employees' "salary reduction agreement" with the church. The salary reduction agreement provides that an employee may direct the investment of a portion of the deferred amounts to the purchase of a whole life insurance contract on the life of the employee, provided at all times less than 50 percent of the total contributions made on the employee's behalf are allocated to the life insurance contract. The insurance contract specifies that (1) an employee may not at any time withdraw cash or surrender the contract except upon attainment of age 59 1/2, separation from service, or death; and (2) insurance premiums may not exceed the limits that apply to annual contributions to a 403(b) tax-sheltered annuity. The IRS ruled that such an arrangement would not adversely affect the status of the church's 403(b) retirement plan. It noted that the income tax regulations specifically permit 403(b) plans to purchase life insurance so long as the insurance is "incidental" in amount. The IRS concluded:

Section 403(b) of the Code provides for a limited exclusion from gross income with respect to amounts contributed for the purchase of an annuity contract, where the contract is purchased for an employee by an employer described in section 501(c)(3) … if all the conditions of section 403(b) are met. Section 1.403(b)-1(b)(4) of the regulations provides that if, during a taxable year of an employee, amounts are contributed by his or her employer for two or more annuity contracts for such employee, such two or more annuity contracts shall, for such taxable year, be considered a single contract …. Section 1.403(b)-1(c)(3) of the regulations provides that an individual contract, or a group contract, which provides incidental life insurance protection may be purchased as a Code section 403(b) annuity contract …. In this case, it has been represented that the annuity arrangement meets the requirements of section 403(b) of the Code, and therefore it meets the form requirements of a section 403(b) arrangement. The limitations imposed by [the insurance contract], if met in operation, comply with the requirement that any insurance protection offered as part of a section 403(b) annuity arrangement be incidental to the annuity. Accordingly, we conclude … that the provision in the Code section 403(b) annuity arrangement in which you participate that allows you to direct a portion of your contribution to the purchase of life insurance does not violate … the regulations, and that [the insurance contract] will be considered incidental within the meaning of [the regulations] so long as the aggregate premiums for such life insurance are less than 50 percent of the aggregate of the contributions allocated to you under [the church's] Code section 403(b) annuity arrangement. Private Letter Ruling 9214026.

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