If we have seasoned profit sharing money in the plan, to avoid the incidental death benefit restrictions, must we have a provision allowing distribution of seasoned assets, or is simply having seasoned money in the plan enough to get around the limitation?

The plan would have to include a provision allowing for the in-service distribution of seasoned money. Note that the entire premium would be taxable to the participant is paid from seasoned money, if the premium exceeds the ancillary benefit limit.

A plan can hold life insurance on a participant's life, but only if the premium stays within the incidental benefit limit. If the premium exceeds that limit, the plan is providing an ancillary benefit that is more than incidental. That is not permissible. The only way the premium can be paid, in that case, is through a distribution; the participant, not the plan, pays the premium. The real question is, under what circumstances can a retirement plan provide benefits that are not retirement benefits? There is a series or revenue rulings that allow a retirement plan to provide non-retirement benefits (in this case, life insurance), as long as the non-retirement benefit is incidental. With regard to a whole life policy, IRS has determined that, if less than 50% of the cumulative contributions allocated to a participants account are used to pay the insurance premium, the insurance (which is a current, not a retirement, benefit) will be incidental to the purpose of the plan, which is to provide retirement benefits.

For whole life, the total of all premiums paid to date for a participant must, at any point in time, be less than 50% of the total of all plan contributions allocated to that participant in the current and all prior plan years.

For term life, substitute 25% for 50%.

For universal life, you need to determine the amount of each year's premium that pays for the insured death protection, and treat that amount as a term life premium.

From Letter Ruling 8725088:

Section 401(a) of the Internal Revenue Code provides that, for a plan to be qualified, the contributions made by the employer must be for the purpose of distributing to employees or their beneficiaries the corpus and income of the fund accumulated by the trust in accordance with the plan.

Section 1.401-1(b)(1) of the Income Tax Regulations states that a plan may provide for the payment of incidental death benefits through insurance or otherwise.

Revenue Ruling 54-51, 1954-1 C.B. 147, states that ordinary life insurance may be considered "incidental" where the aggregate premiums for such life insurance in the case of each participant is less than 50% of the aggregate of the contributions allocated to him at any particular time.

Revenue Ruling 61-164, 1961-2 C.B. 58, states in addition that where only essentially term insurance is provided the amount expended for premiums must not exceed 25% of the allocated contributions, and furthermore that, where both ordinary life insurance and term insurance are provided, the sum of the amount expended for premiums for the term insurance plus 50% of the amount expended for premiums for the ordinary life insurance must not exceed 25% of the allocated contributions.

From Rev. Rul. 76-353:

Section 1.401-1(b)(1)(i) of the regulations provides that a qualified pension plan may provide for the payment of a pension due to disability and may also provide for the payment of incidental death benefits through insurance or otherwise.

Section 1.401-1(b)(1)(ii) of the regulations provides that a profit-sharing plan within the meaning of section 401 of the Code is primarily a plan of deferred compensation but the amounts allocated to the account of a participant may be used to provide for him or his family incidental life or accident or health insurance.

Rev. Rul. 54-51, 1954-1 C.B. 147, states that life insurance may be considered "incidental" where the aggregate premiums for ordinary life insurance contracts in the case of each participant are less than one-half of the aggregate of the contributions allocated to him at any particular time.

Rev. Rul. 61-164, 1961-2 C.B. 99, states that distributions, in the form of one or more permissible benefits such as life, accident or health insurance (to the extent that each such benefit constitutes a "distribution") will be treated as "incidental" if in the aggregate they do not exceed 25 percent of the funds allocated to a participant's account. In a contract of ordinary life insurance the cost of the pure insurance protection (which alone constitutes a "distribution" to the employee) is approximately one-half of its total cost. The limitations, as to "incidental" use of funds for life, accident or health insurance, in Rev. Ruls. 54-51 and 61-164 above which apply to employee's profit-sharing plans are similarly applicable to money purchase or defined contribution plans. See also Rev. Rul. 66-143, 1966-1 C.B. 79.

A contract of ordinary life insurance within the meaning of Rev. Rul. 54-51 and Rev. Rul. 61-164 is a whole life insurance contract with a level amount of insurance for life, while the contract under consideration provides for a decreasing amount of insurance. The ratio of the pure insurance element to the savings element in a decreasing whole life policy is larger than such ratio in a level amount whole life policy. Therefore, such a contract is not a contract of ordinary life insurance within the meaning of Rev. Rul. 54-51.

1.401-1. Qualified pension, profit-sharing, and stock bonus plans

(b) General rules

(1)

(ii) A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. A formula for allocating the contributions among the participants is definite if, for example, it provides for an allocation in proportion to the basic compensation of each participant. A plan (whether or not it contains a definite predetermined formula for determining the profits to be shared with the employees) does not qualify under section 401(a) if the contributions to the plan are made at such times or in such amounts that the plan in operation discriminates in favor of officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees. For the rules with respect to discrimination, see §§1.401-3 and 1.401-4. A profit-sharing plan within the meaning of section 401 is primarily a plan of deferred compensation, but the amounts allocated to the account of a participant may be used to provide for him or his family incidental life or accident or health insurance.