412(i) Defined Benefit Pension Plan,
by Paul M. League, QFP, CFP®
Due to improvements to Pension Law beginning in the year 2000, and
continuing through 2002 and beyond, all of the benefits of the old Defined
Benefit Pension Plan, and substantially none of its’ drawbacks (save that
there are no loan provisions), are resurrected in the 412(i) Pension Plan,
making it an attractive vehicle for meeting retirement needs, while
doing so on a highly cost effective & tax preferential basis.
Why would you, as an employer or business
owner, want to choose a 412(i) Plan over most any other? For many, and
especially following the debacle of ENRON and others since, this is exactly what
the Doctor ordered...safety, security, and guarantees for employees, in
conjunction with reduced corporate taxation, increased tax deductions, and
a guaranteed income at retirement.
First and foremost, any
business entity - including the self-employed - can establish a 412(i)
Plan, and, in case you want to cram in that tax deduction for your prior
tax year, you can establish the Plan prior to year-end, with the actual
funding being delayed until as late as the end of your last extension and
the actual filing of your prior year’s tax return.
A major advantage of a 412(i) Plan
is that it can only be funded with guaranteed insurance products like
qualified Whole Life Insurance (where at least up to $150,000 can be
acquired on a guaranteed issue
basis irrespective of one's good or bad health history) and/or split between Life Insurance & a
Fixed Annuity contract (annuities are used to either add diversification and/or when
more insurance is needed but one might not qualify due to a negative
health condition or history).
Many misunderstand the
reasons why 412(i) Plans must be funded only with specially selected Whole
Life Insurance and Fixed Annuities, as well as the benefits of using these
vehicles as the funding mechanisms. The main advantage lies in their
guarantees, with a close second being that by using whole life insurance
tax deductible contributions into the Plan increase substantially (over
$400,000 more under current inflation adjusted limits). Since such
funding products use the low interest assumptions akin to their rather
conservative guarantees, and one is funding for a future “defined
benefit”, the result is that 412(i) Plans generate larger present tax
deductions. These larger deductions are especially focused on owner/key
employees, and more so than any other available Pension Plan in the market
today. Also, if death occurs prior to retirement then a tax free benefit
is paid to the beneficiaries, instead of a fully taxable account value of
other types of retirement plans, which is of no small significance under
existing Estate taxation law.
Most significantly,
properly designed 412(i) Plans carry with them a separate IRS Letter of
Determination, thereby fully answering a common obstacle of asset tax
planning strategies, which are what Pension Plans, in part, address;
namely, the legitimacy and reliability questions. Tax accountants and
lawyers love these Plans for their clientele for this reason alone, not to
mention the following added and rather significant monetary and control
advantages provided best through a 412(i) Plan:
-
Larger Tax
Deductions Than With Any Other Type of Pension Plan - Tax Savings
-
IRS Letter
of Determination, With Annual Refilling - Plan Confidence
-
Fully
Guaranteed Plan Benefits - Fiduciary Relief
-
Extension
of Contributions to Latest Tax Filing Deadline - More Time/Less Funding Pressures
-
All
Business Entities Qualify - Easy to Help Most Any Business Owner
-
High
Salary Cap of $200,000 (2002) - Largest Available Tax Deduction of Any
Pension Plan
-
Tax
Deductible Contributions Favor Highest Paid With Most Years of Service -
An Owner/Key Employee Bias
-
Greater
Flexibility than Traditional Plans
-
No
Employee Benefit Formulas or Individual Accounts - Allows for Future Plan
Contribution Changes & Ease of Administration
-
Same Asset
Protection as Other Pension Plans - Assets 100% Federally Protected
-
Permits
Conversions of Over-Funded Defined Benefit Plans into 412(i) Plan Along
With Continued, Tax Deductible, Funding
-
Allows for
Executive Carve-Outs Under "Comparability Rules"
-
Benefits
Can Increase Over Time - Inflation Protection
-
Perfect
Vehicle for Absorbing Retained Earnings
-
Typical
Vesting - 6 Yr (graded over the first 6 years of an employee’s service: 0%
yr 1; 20% yr 2; 40% yr 3; 60% yr 4; 80% yr 5; and 100% yr 6+). Employee’s
are vested in their accrued benefit, which is the present value of their
future retirement benefit, often much less than the cash in the annuity
and life policy. Non-vested amounts are used to reduce future plan costs
or to enhance future benefits; therefore, employee turnover benefits the
Plan and the remaining owner/key employees.
-
Flexible
Distribution Options - Lump Sum; Life Income; Continued Tax Deferral
-
Typical PS
58 Costs - Returned Tax Free At Point of Distribution (First Dollars Out)
-
Typical
Administration/Actuary Fees - Cost Effective
So, if you have a desire
to increase tax deductible contributions, and skew those contributions to
percentages where typically over 85% of the tax deduction inures to the
benefit of owner/key employees, rather than rank and file employees, a
412(i) Plan is tailor made for you. The focus then becomes what you
get out of the contributions, not the amount of those contributions over
the years or over the numbers of participants, remembering that not all
employees will stay until retirement. Under these conditions, even
borrowing to fund such a Plan is not only justifiable, but also highly
sensible in cases where the net tax deduction benefits prove out.
Typical Plan structures
are most suitable where a time frame to retirement is not less than 5-10
years or more depending on age; however, due to Plan flexibility, and
specifically the ability to modify the underlying insurance funding
vehicle, even shorter time frames can be successfully accommodated.
The 412(i) Plan is not,
therefore, an "employee benefit plan", but rather an owner/key employee
"take control & biased plan”, beautifully designed to favor a specific
class of employees that are both highly compensated, and with the most
years of service. Typically, these are owner/key employees. While this
may not appear "politically correct", shouldn’t business owners and
entrepreneurs really get the lion share of their creations? They have, in
addition to their creativity and the company that grew from that, all of
their own capital at risk, and all of the responsibility that comes with
creating & maintaining jobs for others, which is part and parcel of all
business enterprises. A 412(i) Plan, while admittedly largely benefiting
owner/key employees, can also benefit rank and file employees if they too
stay loyal, long term committed company contributors.
-----
Since the original writing of this article the government passed the
Pension Protection Act of 2007, which introduced, for some small business
owners, rather attractive additional alternatives. Please click the
following link to learn about the unique advantages of what are best
referred to as "HYBRID
PENSION PLANS".
Disclaimer: The material discussed
herein
is meant for general illustration or informational purposes only and is
not to be construed as investment advice. Although the information has been gathered from sources believed to
be reliable, it is not guaranteed. Please note that individual situations
can vary; therefore, the information contained herein should be relied upon only when
coordinated with individual professional advice. We are not licensed for
and therefore do not provide tax or legal advice.
About
the Author: Paul M.
League, QFP, CFP® is the Founding Principal of both League Financial & Insurance
Services (www.LeagueFinancial.com) & League Financial Services (www.LeagueFS.com),
which are privately held companies
located in Palm Desert, CA.
Paul and his companies specialize in assisting clients to
create, expand & preserve assets. Contact Information: Paul M. League, QFP, CFP®, P.O. Box
11800, Palm Desert, CA 92255-1800 · 800.482.5347 ·
Info@LeagueFinancial.com.
©Paul M. League. All Rights Reserved.
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