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412(i) Fully Insured Defined Benefit Plans FAQs
What is an IRS Code Section 412(i) Defined Benefit Pension Plan? Who should consider a 412(i) plan? What are benefits of the 412(i) Plan for me and my company? What are the advantages of a 412(i) plan over a traditional defined benefit plan? Why is it desirable to qualify under 412(i) of the IRS Code? How does a 412(i) Plan work? What requirements must a plan meet to qualify under 412(i)? What is the maximum benefit in a 412(i) plan? Are 412(i) plans safe? How do I make sure that my plan is approved by the IRS? How are the contributions for a 412(i) Plan calculated? What is the advantage of using contract guarantees to determine the funding? Who pays for a 412(i) Plan? How may I take distributions from my 412(i) Plan? Are the contributions to my 412(i) plan tax-deductible? Is there a tax on the growth of assets in the 412(i) plan? Are my 412(i) Plan contributions subject to the Alternative Minimum Tax (AMT)? With a 412(i) Plan can I receive an income tax deduction in excess of my salary? Is an enrolled actuary required for my 412(i) plan? If I have another plan in place can I still adopt a 412(i) plan? What happens if someone dies while an active plan participant? At retirement, what happens to the insurance in the plan? How does the 412(i) Plan provide disability benefits? How does the 412(i) Plan affect my employees*? How do I fund my 412(i) Plan? If the business has a bad year, can they skip a year of funding? Who must be included in the plan? Can I amend my 412(i) Plan? Can I terminate my 412(i) Plan? Where do you go to find a 412(i) plan? Why does Advanced Corporate Planning sell these plans? What is the IRS Tax Code covering 412(i) Plans What is an IRS Code Section 412(i) Defined Benefit Pension Plan?A 412(i) Plan is a defined benefit plan funded with guaranteed life insurance and/or annuity contracts. It is a custom-designed plan that can be used with any investment grade life insurance or annuity contract. A 412(i) plan is the only defined benefit plan that is exempt from the minimum funding requirements of Section 412 of the Internal Revenue Code. The plan is governed by the Employee Retirement and Income Security Act of 1974 ("ERISA"), the federal act governing the funding, vesting, administration and termination of private pension plans. These are also known as an insurance contract plan or a Fully Insured Defined Benefit Plan. Are 412(i) plans new to the retirement planning marketplace?No. These plans have been around since ERISA (in 1974) or even before. They were referred to as fully insured defined benefit plans. In past years, before the demise of retirement endowment contracts, they were fully funded with a retirement endowment contract issued with a face amount equal to 100 times the normal retirement benefit. They are not a grey area of the law and are, in fact, a very conservative approach to retirement plan funding. All benefits are guaranteed by a highly rated insurance company. Who should consider a 412(i) plan?The best candidates are Sole Proprietors, Partnerships, LLC, Corporations, or any other legally recognized business entity. A 412(i) plan is most advantageous for small stable businesses with owners who are age 45 and over seeking to maximize tax deductions and provide a substantial retirement benefit for themselves and other long-term quality employees. The business will typically have 10 or fewer employees. The best candidate is a one employee business wanting to maximize deductible contributions to retirement planning and minimize W2 income. What are benefits of the 412(i) Plan for me and my company?The 412(i) plan is appropriate for a business owner who would like to take advantage of generous tax deductions available for contributions to defined benefit pension plans. The plan is inexpensive to establish and maintain. Contributions to the plan are income tax-deductible. The plan assets grow income tax-deferred and taxes are paid only when the benefits are distributed at retirement. Think of it this way: for each dollar you contribute to a 412(i) plan, the government funds thirty to forty cents for your retirement through the available tax deduction. While growing income-tax deferred, your plan assets are protected from the claims of your creditors, provided the plan is properly established. In addition, the government permits you to contribute substantially more money to your 412(i) plan than to an IRA, 401(k) or profit-sharing plan. Your plan benefits are fully guaranteed by the life insurance or annuity contract(s) owned by your plan. (see below) Low costs to Implement. We can implement custom 412(i) plans and work with an Actuary to complete them. This reduces the annual cost of the plan. Your sole proprietorship, S or C Corporation, family limited partnership (FLP) or family limited liability company (LLC) can adopt the 412(i) defined benefit pension plan. As an added benefit, your 412(i) plan may eliminate estate taxes on an IRA! (See discussion below) In summary, the benefits of your 412(i) plan are as follows:
What are the advantages of a 412(i) plan over a traditional defined benefit plan?412(i) plans invest exclusively in permanent life insurance and/or annuity contracts with guaranteed rates of return. Traditional Defined Benefit plans can invest in term or permanent insurance and/or annuities or investments like mutual funds or stocks. 412(i) plans protect participants and employers against negative returns, bear markets and poor investment judgment. A 412(i) plan:
This type of plan enjoys certain advantages over the traditional defined benefit plan and is worth exploring if you are the owner of a small business. These advantages create a plan that, compared to a traditional defined benefit plan, will produce:
Why is it desirable to qualify under 412(i) of the IRS Code?Employers can usually achieve the largest tax deductions available for any type of qualified retirement plan and the employers and employees are protected from market fluctuations. These plans also provide flexibility and security. Plans qualifying under 412(i) are exempt from the funding limitations of 412. Therefore, these plans can provide deductions often 3 times greater than traditional defined benefit plans and possibly as much as 6 times more than defined contribution plans. They provide employers with the ability to "fast fund" a retirement plan for an older employee without increasing costs for younger employees. How does a 412(i) Plan work?
What requirements must a plan meet to qualify under 412(i)?
What documents must be prepared to establish the 412(i) Plan?The documents required to establish your 412(i) Plan are:
What is the maximum benefit in a 412(i) plan?The maximum retirement benefit that can be funded for in the year 2002 either:
Over their lifetime, the maximum a "typical client" can put away will vary based on the client's age and Normal Retirement Age, but due to conservative life insurance and annuity guaranteed assumptions, contributions may be as much as 300% the contributions made to a traditional defined benefit plan and 600% more than in a defined contribution plan. Can a plan be designed to "spend" at a certain level?Yes. Contributions can be made at whatever rate you are comfortable with. Are these plans safe?Yes. 412(i) Plans are a well-established part of the pension plan code. 412(i) provides an additional layer of safety from investment risk for both the employee and the employer. Contributions are invested in either life insurance contracts and/or annuities providing guaranteed interest rate returns and security. 412(i) Plan documents are reviewed by the IRS and receive a prototype determination letter insuring that the plan is properly set-up. How do I make sure that my plan is approved by the IRS?We file the plan along with other required documents with the IRS and you will receive a determination letter directly from the IRS approving the plan. How are the contributions for a 412(i) Plan calculated?The contribution to your 412(i) plan is calculated by using the guaranteed interest rates and guaranteed purchase rates of the insurance and/or annuity, together with the promised benefit at retirement (target). The number of years to normal retirement age (NRA) is calculated leaving us with the annual level premium needed to reach the target at retirement.
Do the contributions remain level forever?The contributions will gradually decrease since the excess interest earned over the guaranteed rate must be used to reduce the following years contribution. The dividend payable on the life policy will also be used to reduce the following years contribution. However, if the deduction decrease becomes a problem, it is likely the plan benefit can be increased to compensate for that since the maximum benefit levels are subject to annual cost of living increases declared each year. What is the advantage of using contract guarantees to determine the funding?Typically, the contract guarantees are much lower than the interest rate used to calculate funding for a traditional defined benefit plan. This results in higher contributions and, higher deductions under a 412(i) plan. Example group annuity and whole life contracts have a 3% guarantee. A traditional defined benefit plan uses 5.84% to calculate contributions. Who pays for a 412(i) Plan?The business makes the 412(i) plan contributions and pays the set-up and annual administrative fees. The business pays for PBGC (pension benefit guarantee company) insurance, But unlike traditional defined benefit plans, PBGC premiums are a limited to a flat rate of (currently) $19.00 per plan participant per year. Is there any cost to employees?This depends on your 412(i) plan design. If you have life insurance in the plan, participants recognize the cost of the "current economic benefit" provided by the insurance as part of their annual income. The "economic benefit" is calculated according to Table 2001. In some cases, the rate may be lowered by using a declared insurance company term rate. In all cases, the specific "current economic benefit" for each employee will be provided annually to the employer for distribution. How may I take distributions from my 412(i) Plan?Before reaching age 59 1/2, you may take penalty-free distributions as long as they are uniform, systematic distributions based upon your life expectancy. A pre-59 1/2 lump sum distribution will trigger a penalty of 10% of the amount distributed (the I.R.C. Section 72(t) penalty), plus applicable income taxes. If you have reached age 70 1/2 and you are retired you must take the required minimum distribution from your 412(i) plan (the calculated annual planned benefit). If you have reached age 70 1/2 and you are not retired you may defer distributions until your retirement. Are the assets in my 412(i) Plan protected from lawsuits and creditors?Yes, your 412(i) plan is creditor-protected. A properly drafted 412(i) plan is an ERISA defined benefit pension plan. As such, its assets are fully immune from the claims of creditors. Are the contributions tax-deductible?Yes. The employer's contributions to your 412(i) plan are tax-deductible for the employer, Plan fees deductible, and the employees' income taxes on benefits are tax-deferred. Is there a tax on the growth of assets in the plan?No. All accumulations grow tax-free. Are my 412(i) Plan contributions subject to the Alternative Minimum Tax (AMT)?No. Contributions to your 412(i) Plan are not subject to AMT, and might lower your overall exposure to AMT. This is a powerful tax saving opportunity. With a 412(i) Plan can I receive an income tax deduction in excess of my salary?Yes, you can receive an income tax deduction in excess of your salary. Generally, all types of compensation are used in calculating the formula for determining benefits in a 412(i) plan. This includes: base salary; bonuses; vacation pay; overtime; and any other compensation that meets your definition as he employer. In addition, amounts that you contribute to a 401K plan, an IRS Section 125 ("cafeteria") plan or an IRS Section 127 (education assistance) plan can be used in determining the total allowable contribution you may make to your 412(i) plan. Is an enrolled actuary required?No, the guarantees in the contract insure that the plan can never suffer any losses or be under-funded. In addition, each year's gains are reflected in a reduction of that year's contributions. This means the plan is always perfectly funded. The 412(i) Plan needs no actuarial certification saving the cost of an enrolled actuary. If I have another plan in place can I still adopt a 412(i) plan?Yes. How this is achieved will depend on the current plan type. Talk to us about current plan specifics. What happens if someone dies while an active plan participant?Life Insurance: The beneficiary receives the difference between the cash value (CV) and the total death benefit income tax free. The CV, minus the taxes paid for the "current economic benefit" is taxed as ordinary income. For example: Assume that the death benefit is equal to $500,000 Annuity: The annuity is surrendered and the surrender value is paid to the beneficiary. This amount will be income taxable. At retirement, what happens to the insurance in the plan?The participant may elect to continue the permanent life insurance benefit after retirement by buying it for its cash value, or the policy can be surrendered by the plan for its cash surrender value which can be converted into an income stream of up to $160,000 per year for life for each participant. If the insured chooses to keep the life insurance, the policy will be individually owned and with proper planning, may not be subject to estate tax. If I am already retired, may I contribute to my 412(i) Plan?Yes, if you are already retired or are over age 70, you may contribute to your 412(i) Plan for up to five years, under certain circumstances. How does the 412(i) Plan provide income replacement upon a participant's death?The 412(i) Plan, fully-funded, can provide your surviving spouse or children up to $13,333 per month for the rest of their lives. How does the 412(i) Plan provide disability benefits?Following the onset of a disability the cash value of the insurance contract can provide disability income. Fully-funded, the disability income for each participant can be as high as $13,333 per month for the rest of the participant's life. How does the 412(i) Plan affect my employees*?Since it is governed by ERISA, your 412(i) plan must allow employees to participate in the plan. Depending on the circumstances, some employees can be "carved out" of the plan. Employee benefits are determined by a variety of factors. For example:
*Where the business entity is a family C or S Corp, FLP or LLC, "employees" may even be you and your children. If one or more of the employees of the business will not be in the plan a minimum of 10 years, can they still enjoy a maximum benefit?Yes. The 412(i) plan can be designed to provide a maximum retirement benefit equal to the lesser of the current maximum dollar amount (see above) or 100% of current monthly income. How do I fund my 412(i) Plan?Your 412(i) Plan is funded with retirement annuities or investment-grade life insurance contracts. These investment assets make security and simplicity the hallmarks of the 412(i) Plan. As an example, Indexed Annuities or Indexed Life Insurance may allow you, as the investor, to receive a guaranteed 3% interest on your account or 100% of the annual return of the Standard & Poor's 500 (with a "cap"), whichever is greater. This arrangement protects both your downside and your equity upside. While your retirement benefits are calculated on the guaranteed part of the contract, the historic return on Indexed Annuities generally exceeds that guaranteed rate, so your returns could exceed the guarantee. If the business has a bad year, can they skip a year of funding?No. 412(i) Plans must be funded each year. Plans can be amended or terminated to accommodate your needs. Who must be included in the plan?All full-time, non-union employees must be covered. For employers with more than one employee, defined benefit plans must include a minimum of 2 employees. The employer can exclude part-time employees (less than 1000 hours), employees less than age 20½ or who have less than one year of service with the company, as long as the lesser of 50 employees or 40% of all employees are covered. The Affiliated and Control Group Rules of IRS Section 414 do apply; All eligible employees of companies who fall within the brother-sister and controlled group rules of 414 must be included in the plan. Is my private family foundation permitted to adopt my 412(i) Plan?Yes, your family foundation may adopt the 412(i) Plan for any employee (e.g., you , your children or any other foundation employees). A non-qualified deferred compensation plan might also be a suitable alternative. Can I amend my 412(i) Plan?Yes, your 412(i) plan may be amended. If a plan amendment will result in a significant reduction in the rate of future benefit accruals, the plan administrator must notify all participants, certain beneficiaries, and any union representing plan participants. The required written notice is often referred to as the 204(h) notice. For example, if your plan changes the definition of compensation in a way that would lower benefits, a 204(h) notice is required. Can I terminate my 412(i) Plan?Yes. As plan sponsor, you may terminate your 412(i) plan as long as the plan document provides for termination. In general, a plan must be fully funded and there must be a bona fide business reason for the plan termination, including: a change of ownership of the business by merger; the liquidation or dissolution of the employer; a change in ownership through sale or transfer; the existence of adverse business conditions; and the adoption of a new plan. Upon termination, plan proceeds may be rolled over into an IRA, tax-deferred. Where do you go to find a 412(i) plan?Advanced Corporate Planning, for one.Click here for contact form Why does Advanced Corporate Planning sell these plans?We believe it is a market that is under-served. We specialize in the small business retirement plan market place. It is, therefore, natural that we market 412(i) plans. These are specialized plans that create large deductions. In the right situation, there is no other plan that will meet the needs of the small business owner. If a traditional defined benefit plan does not create sufficient deductions, there is no where else to turn but to a 412(i) fully insured plan. NOTE:
ALL information contained in this site is for illustration purposes only, and by NO means should be considered individual tax or legal advice under any circumstances whatsoever!
Lynn R. Siewert AIMC
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