Can Life Insurance Be Funded as a 403(b)?

Q. You have a client who works for a public school district. He has had a whole life insurance policy under a 403(b), funded pretax from my paycheck, through the school district for more than 20 years. The third-party administrator says it will no longer fund the life insurance policy due to a change in federal tax law that says that life insurance can longer be funded as a 403b. Would the client be grandfathered in so he does not lose his life insurance?

A. it is correct in that the IRS did provide grandfathering for certain life insurance contracts that were in place on or before Sept. 23, 2007, which the client’s was. However, there were rules put in place at that time that the insurance contract had to satisfy certain rules. 

For example, less than 50% of the contributions had to be used to purchase the insurance benefits. This satisfies a rule that is called the “incidental benefit rule.” The incidental benefits rule states that the contract must be designed to provide retirement benefits.

It would be good to proceed in doing the following:

1. Contact the TPA to see if they have determined that your insurance contract violates this rule. They may or may not know the answer to this. But clearly if the insurance that you purchased is grandfathered under IRS regulations you are ok to continue it.
2. Contact the insurance company that handles your investment. They should be familiar with this rule and be able to tell you if it is a grandfathered contract. If it is, you are fine. If not I would ask them what your options are under the contract.
3. And finally, if the contract was not one that was grandfathered, why did the insurance company not notify you or your employer before 2023. 

The citations under the 403(b) regulations to provide either the TPA or the insurance company are: Treasury Regulations 1.403(b)-6(g) and 1.403(b)-11(f); and IRS website IRC 403(b) Tax-Sheltered Annuity Plans - Overview of the 403(b) Final Regulations | Internal Revenue Service (irs.gov)