Fully Insured Defined Benefit Plan
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It is estimated that it will take up to One Million Dollars to meet your retirement needs. Do you know Where that $1,000,000 will come from?
Are you a small business owner or professional with few or no employees?
Are you within 5 - 10 years of retirement with a need to accumulate significant retirement assets on a fully guaranteed basis?
Do you want to put away more each year than the 25% of payroll or $40,000 per individual limit permitted by most qualified retirement plans?
Is yours an established business where there is a need or desire to maximize contributions and tax deductions each year until retirement to a greater extent than is possible in other qualified retirement plans?
There is a plan, approved by the IRS, that will allow you to meet these objectives: a 412(i) Defined Benefit Plan.
A 412(i) plan is a defined benefit retirement plan, the funding requirements of which fall under IRC Section 412(i). If a plan meets the requirements of this subsection, it is exempt from the complex funding rules of Section 412 of the Internal Revenue Code applicable to all other defined benefit plans.
Defined benefit plans are the only qualified pension plans that allow the significant accumulation of retirement assets in a short period of time. This special type of defined benefit plan, a 412(i) plan, generates the maximum deduction allowed by any plan type on a fully guaranteed basis. Guarantees are derived from insurance and/or annuity contracts and are dependent upon the claims-paying ability of the issuing company.
Fully insured, 412(i) defined benefit plans have been around for over 50 years and may be an attractive solution. They offer simplicity, maximum current tax-deductible contributions and guaranteed retirements benefits.
Defined Benefit Plans
The only qualified retirement plan to provide employees with a guaranteed retirement benefit payable at normal retirement age, with reduced benefits payable at an earlier retirement date.
Benefit is usually a monthly benefit based on compensation and years of service, and payable for the lifetime of the participant.
Plans may allow for "cash out" at retirement, with participant receiving a single lump sum instead of monthly payments.
Employer has obligation to make necessary contributions. Premiums may be paid to the Pension Benefit Guaranty Corporation to insure the benefits.
A fully insured 412(i) plan provides an attractive alternative solution offering simplicity, maximum current tax-deductible contributions and guaranteed retirement benefits.
412(i) Plan Features
A 412(i) Defined Benefit plan is a special type of defined benefit pension plan, with three significant characteristics:
Defined Benefit 412(i) Plans allow deductible contributions in excess of 25% of compensation.
412(i) Plans are ideally suited for the small business employer (6 or less employees) who was unable to save in the early years and now, with stable future business profits, desires to put away a very large, tax deductible contribution.
In addition to providing funding for future retirement income, tax deductible 412(i) contributions reduce current taxable income and increases tax deductions.
Self employed individuals, with expectations of stable future income, may find the features of the 412(i) plan attractive.
Business owners, starting a second career, should give consideration to the creation of a 412(i) Defined Benefit Plan.
Additional protection for family and heirs may be provided with the addition of an insured death benefit to the plan. This also further reduces taxable income and increases income tax deductions.
In order for a plan to qualify under Section 412(i), certain requirements must be met:
These requirements are easily satisfied using IRS-approved prototype plans, funded by products designed specifically for this marketplace. Advanced Corporate Planning can provide products that are ideally suited for use under a 412(i) plan, together with prototype defined plan and trust allowing the plan to meet fully insured requirements.
A 412(i) plan can provide substantial retirement benefits under this simple and secure program. The accrued benefit for participants is simply the cash surrender value of all insurance contracts. It provides a maximum current tax deductible contribution for the business. Some of its other advantages include:
The 412(i) plan may not be the ideal plan for all situations and businesses. Given the large, required contributions that must be made each year, it works only when the business is established and highly profitable. It works best when there are very few employees (less than five); and where the owner is fifty years old or within 10 years of retirement and is older than any of the firm's employees. In brief, its disadvantages include:
How 412(i) Plans work
When compared with other types of defined benefit plans, larger current contributions are created with a 412(i) plan. Life insurance and annuity guaranteed assumptions are conservative. A Traditional Defined Benefit Plan will have an interest rate assumption much higher than the guaranteed interest rate in a fully insured plan. The lower the plan assumptions, the higher the required contribution. It's that simple.
Here's how it works:
Investments & Gains
It can be expected that some insurance contracts may earn interest above the guaranteed rate. Dividends may be paid on participating life insurance contracts. Both dividends and interest in excess of the guaranteed rate will decrease the employer's contribution in a following year. It should be noted that life insurance dividends for all defined benefit plans must be used to reduce the premium.
Such gains will tend to increase over time, essentially lowering the cost of the 412(i) plan. Hence, if all else remains unchanged, the 412(i) plan's tax-deductible contributions will be greater in the early years. In contrast, due to limitations imposed by the Omnibus Budget Reconciliation Act of 1987 (OBRA), the funding costs for traditional defined benefit plans will often tend to increase over time.
Contributions for traditional defined benefit plans fluctuate due to actuarial and investment experience. To ensure minimum funding standards are met, an enrolled actuary is required to certify the plan each year. Investment rates are not known and can vary greatly over time. It is this type of variability that can cause a traditional defined benefit plan to become over-funded (a higher investment return than expected) or under-funded (not enough contributions, given the actual investment return and benefits paid.)
A 412(i) plan needs no actuarial certification, as only enough money to provide the guaranteed benefits can be paid to the plan. There can be no over-funding or under-funding problems. This is simple, too.
A 412(i) plan is subject to the same maximum benefit limitations and top heavy provisions as a traditional defined benefit plan. Let's examine each of these in detail.
Top heavy rules are simplified:
Advanced Corporate Planning provides solutions to this problem through plan design, selecting benefit formulas that are much higher than the minimum top heavy requirements.
The ERISA section that limits the overall plan benefit is known as the 415 limit. Section 415 applies to all defined benefit plans in the same way. It dictates the maximum retirement benefit. Currently, this provision limits a defined benefit plan to a maximum of $160,000 of annual income. This amount is reduced if the actual retirement age is less than Social Security retirement age.
A common technique used to increase the ultimate retirement benefit beyond the Section 415 limit is to roll the lump sum value of the retirement benefit into an Individual Retirement Account (IRA). Before this can be done, however, the lump sum benefit to be rolled out of the plan would need to comply with the Section 415 benefit accrual limit and the provisions of the Retirement Protection Act of 1994 (RPA '94), a provision within the General Agreement on Tariffs and Trade (GATT) treaty.
RPA '94 specifies that the maximum lump sum distribution must be calculated using the GATT-provided mortality table and an indexed interest rate that may be set higher than the 412(i) guaranteed interest rate. These provisions may reduce the amount that may be taken in the form of a lump sum distribution when compared to pre-GATT provisions. It should be noted that this will only affect benefits that are taken in the form of a lump sum and only as they approach the Section 415 maximum dollar limit.
Advanced Corporate Planning sometimes suggests minimizing this lump-sum distribution problem by using a plan designed to initially be below the Section 415 limit, with the expectation that the lump sum will be rolled out of the plan into an IRA. Even with this reduced limit, the 412(i) plan provides a much larger current deduction when compared to a traditional defined benefit plan.
To maximize the available benefits of a 412(i) plan, an option to purchase life insurance under the plan may provide up to one half of the plan retirement benefits. The guaranteed cash values and guaranteed premiums of Advanced Corporate Planning suggested whole life insurance contracts are ideal for funding such a 412(i) plan.
Life insurance in all qualified retirement plans must comply with the incidental insurance rules discussed in Treasury Reg. Section 1.401 (b)(1)(i). These provisions place a limit on the amount of life insurance that may be purchased under the plan. Generally, a defined benefit plan can provide no more than 100 times the projected monthly retirement income as a pre-retirement survivor benefit. An alternative provision under Rev. Rul. 74-307 instead allows up to one half of the level premium to be used to purchase life insurance contracts within a defined benefit plan.
While life insurance does not need to be offered under a 412(i) plan, this feature does provide important additional benefits for a participant. If there is an insurance need, the participants may obtain the benefits of life insurance on a pre-tax basis. For highly profitable, closely held businesses, there often exists a substantial insurance need for the owner. A 412(i) plan can maximize the current deductions, and can also meet these needs by funding the benefit with life insurance contracts.
Taxable "Economic Benefit"
When life insurance is included inside a pension plan, the participants must recognize as a taxable cost the current "economic benefit" provided by the plan (IRC Section 72(m)3(B), Reg. Section 1.72-16(b)). Each participant is then taxed currently on the cost of the "pure" life insurance benefit. The cost of this current benefit is known as the P.S.58 cost. The cost is determined by using the one-year term rates published in Revised Rules 55-747. if, however, the insurance company's one-year term rates are lower, the participant may use the insurer's lower rate to determine the amount to be included in gross income (Revised Rules 66-110, 1966-1 CB 12).
Advanced Corporate Planning can provide policies with very competitive one-year term rates. For example, the initial year's taxable income for a $1,000,000 face amount for a 50-year-old is:
Overcoming the $40,000 Contribution Limit
Defined Contribution plans, especially 401(k) plans, have enjoyed tremendous popularity over the past 10 years. Now some employers are shifting toward defined benefit pension plans that deliver guaranteed benefits and large tax deductions.
Successful small business owners and professionals are expressing renewed interest in insured fully guaranteed defined benefit plans to assure enough money is set aside at retirement.
Recent pension legislation now encourages this rebirth, permitting much higher tax deductions than defined contribution or 401 (k) plans. And employers are no longer restricted in what they can contribute to a Defined Benefit Plan due to participation in a prior Defined Contribution Plan.
Age-based plans like Age Weighted or Select pension or profit sharing plans work well in shifting the majority of the plan contribution in favor of the older business owner. But the problem with these plans is that they are capped at the $40,000 contribution limit.
The Solution: Fully Insured 412(i) Defined Benefit Plans
As you can see from the figures, plan deductions can be significantly higher than any other plan type. It is possible to generate deductions well over $100,000 annually. Maximum insurance amounts can reach up to $3,000,000!
Add to this the other advantages of a fully insured plan:
Maximum Deductions & Maximum Insurance
Retirement Age: 60 Amount of Tax Deduction
Retirement Age: 55 Amount of Tax Deduction
*Lump sum payments under defined benefit plans after 1994 are limited by the provisions of the GATT bill.
A participant will be taxed on any distributions received as cash under a retirement plan upon termination or separation from service (IRC Section 402). These amounts are often rolled over into an IRA to avoid current taxation until minimum required distributions commence. The taxable amount from any distribution of the life insurance contracts will be reduced by the cumulative taxable P.S.58 costs, previously declared as income.
Should a defined benefit later fail to comply with IRC Section 412(i), it does not automatically become disqualified. It may be converted into a traditional defined benefit plan under Section 412. Due to the large contribution and conservative assumptions, conversion will most likely result in the plan becoming fully funded.
One technique that some businesses will use is to adopt a 412(i) plan when the owner is earning a very high income. The retirement definition may be selected to recognize the best three consecutive year period of average income. If the preferred participant's income is expected to decrease as he or she gets older, at some point (usually after five years), the 412(i) plan is converted to a fully-funded defined benefit plan. Contributions may be eliminated or greatly reduced using this approach, ensuring maximum current contributions in the highest income years and lower or no contributions as the owner approaches retirement and is perhaps working less. This flexibility is a significant advantage of the 412(i) plan for particular situations.
There is an easy to understand retirement plan called the fully insured 412(i) defined benefit plan that, in a short period of time, results in a significant accumulation of retirement assets.The Result:
A 412(i) plan is simple and may perhaps be the ideal plan for the owner of a small business or professional enterprise who desires to maximize his or her current tax deduction and secure guaranteed retirement income. The contributions are, by design, quite large in the early years of the plan and may be less appealing as the number of plan participants increases. Introducing life insurance to fund a portion of the benefit will provide increased initial contributions and a current pre-tax life insurance benefit for each participant. Advanced Corporate Planning provides 412(i) plans that are unique tax reduction tools for today's small business owner.
You should consult with your tax and legal advisors regarding your own situation before implementing any strategy.
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