There are many financial experts who adamantly state that qualified plans funds (e.g., 401k) should never be used to purchase life insurance. Although it is restricted, you could use your Solo 401k to invest in life insurance. This makes sense in the following cases:
- You may not otherwise qualify for life insurance because of health reasons;
- You don’t have other disposable funds; or
- Your want more protection for your beneficiaries.
If you are interested in purchasing life insurance with your Solo 401k, note the following:
General guidelines for investing in life insurance with Solo 401k
In general, no more than 50% of Solo 401k or Individual 401k plan contributions may be used to purchase “whole” life insurance (i.e., policies with both nondecreasing death benefits and non increasing premiums), and no more than 25% may be used to purchase term life insurance.
Different treatment for Solo 401k contributions used to purchase life insurance
When a self-employed business owner invests her Solo 401k in life insurance, he does not receive a tax deduction for Solo 401k contributions attributable to the purchase of a life insurance benefit.
Ownership of life insurance policies
The Trustee of the Solo 401k is the owner of any life insurance policies purchased under the Solo 401k plan. Further, any life insurance policy purchased under the Solo 401k Plan must designate the trustee as owner and beneficiary under the policy. The insurance premiums are paid with funds from the Solo 401k’s checking account.
Reasons not to invest Solo 401k plan assets in life insurance
Although IRC 501(a) provides tax-exempt status to a qualified plan, including a Solo 401k, resulting in tax-deferred investment accumulation on the Solo 401k plan assets, a life insurance vehicle is tax-deferred on its accumulation outside of the plan as well. As such, the assets in the Solo 401k plan that are used to purchase life insurance are not getting any special income tax benefit on the accumulation in the contract by being held in the Solo 401k plan. The purchase of life insurance will reduce the amount available for investing in other assets such as real estate. Although life insurance may have an investment element (i.e., cash value accumulations), you may be foregoing higher returns by not investing all your Solo 401k plan in other investments.
This information is provided is for educational purposes and it is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. One must always consult with their respective professional in all such matters.