412i Frequently Asked Questions

What is a 412(i) Defined Benefit Pension Plan?

A 412(i) defined benefit pension plan, referred to in IRS regulations as an insurance contract plan, is the only defined benefit plan that is exempt from the minimum funding requirements of §412 of the internal revenue code. This type of plan, therefore, 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:

• larger initial deductions
• more stability in the contribution level
• simpler plan administration, and
• a secure promise of future plan benefits bases upon the guarantees in the life insurance policy

What are the advantages of a 412(i) defined benefit plan over a traditional defined benefit plan?

A 412(i) insurance contract plan:

• does not require an enrolled actuary
• is not subject to the full funding limitation tests of a defined benefit plan
• is required to use the insurance contract guarantees as funding assumptions
• can be designed to eliminate the potential of excess plan assets, that, in a traditional plan, would be subject to taxes and penalties of 80% or more upon termination of the plan
• produces an understandable accrued benefit since it is simply the cash value of contracts funding the participants account
• creates larger initial deductions than a traditional plan since the funding assumptions are required to be much more conservative
• provides retirement benefits that are based on the guarantees in the life insurance policy and not just the financial strength of the particular employee providing the plan

What requirements must be met to qualify as a 412(i) defined benefit plan?

Requirements under §412(i) of the Internal Revenue Code are:

• The plan must be funded exclusively with annuity products, or a combination of life insurance and annuity products, issued by an insurance company
• The benefits provided each individual must be equal to the values provided in the insurance contracts.
• Life insurance dividends and excess annuity interest must be used to reduce the following years plan contribution
• No policy loans are allowed under the contracts
• The products must provide all benefits stated in the plan using guaranteed (values at normal retirement age)
• The insurance products must provide level annual premiums payable to (normal retirement age)
• Forfeited benefits must reduce contributions. Forfeited benefits occur when employees leave before becoming fully vested in the plan. The unvested portion of the terminated employees benefit must stay in the plan, which means that a lower contribution will be required to fund the remaining employee's benefits.
• Benefits must be guaranteed as long as premiums are paid when required
• Policies cannot be assigned, nor can policy loans be taken while the policies are part of the plan

How does the initial deductible contribution required in a 412(i) plan compare to a traditional defined benefit plan?

Generally, a plan funded with annuity contracts may DOUBLE the deductions allowed under a traditional plan. A plan funded with both annuity and the maximum life insurance allowed may TRIPLE the deduction allowed in a traditional defined benefit plan. See the appendix page that illustrates the maximum first year contribution levels for a 412(i) plan. These contribution levels are shown from ages 35 to 65. Comparisons are made for plans funded entirely with annuity contracts and those funded with a combination of annuity and the maximum amount of life insurance available under the incidental insurance rules for qualified plans.

Are 412(i) plans new to the retirement planning marketplace?

No. These plans have been around since ERISA (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 based on the life insurance policy's guarantees.

Where do you go to find a 412(i) plan?

Generally, you will go to a financial professional that sells these types of plans. The funding must be in insurance company products and be based on the guarantees in the policy. There are very few insurance companies who offer insurance products used in small business retirement plans so there are very few companies that market 412(i) plans. That is why it is a plan that is somewhat unfamiliar to most CPAs and small business owners.

Why should an agent/advisor market these plans?

It is a market that is under-served. Although, one should work with those whom specialize in the small business retirement plan marketplace. They will design, administer, and fund plans for the small business. 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 nowhere else to turn but to a 412(i) defined benefit plan.

How much can I contribute?

How much you can contribute depends on the amount of the retirement benefits and the amount of time remaining until each participant reaches retirement age as specified in the plan. Because there is some flexibility in specifying the benefits and the retirement age at which benefits will be paid, a plan can usually be designed with your budget in mind.

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.

Why does it make good economic sense to use life insurance as part of the funding of my defined benefit plan?

• It can assure your estate of needed liquidity on a tax deductible basis. In fact, it is the only safe way to use pre-tax dollars
• It can reduce your cost of providing needed life insurance to your family and your business
• It helps guarantee your retirement benefit and eliminates the uncertainties of a down market
• It guarantees you and your eligible employees a benefit if they die before reaching retirement age
• A disability provision can be added to continue the contributions if disabled during your plan funding years (eligibility requirements apply)
• The life insurance portion of your plan can be continued after retirement
• The higher tax deduction allowed by your defined benefit plan with insurance can substantially reduce Retained Earnings
• Administration costs of a 412(i) defined benefit plan are reduced
• The difference between the policy face amount and the cash value is paid out income tax free
• Your retirement security is represented in the cash and annuity values in the insurance products used. Therefore, you never have to be concerned with not having exactly the retirement income for which you have planned

So, all of my contributions are tax deductible, right?

Yes, all employer contributions required to fund benefits are deductible, as they are with any qualified pension plan.

Do I have to pay taxes on any earnings in the plan?

No. Earnings in the plan accumulate tax deferred. If life insurance is used to fund any of the benefits, a relatively small amount of income must be recognized each year by each participant covered by life insurance. This amount is known as the economic benefit. Other than this, there is no tax incurred by participants until retirement, when the benefits become subject to taxation.

What financial vehicles can I use to fund a 412(i) plan?

412(i) plans can invest in any insurance product that meets IRS guidelines with guaranteed interest and annuity purchase rates. This includes cash value life insurance and deferred annuities filed as being of the same series.

Who do I have to include?

Employers must offer participation in the plan to all full time employees who are over age 21 and are US citizens. Waiting periods, vesting schedules and benefit accrual formulas can be used to make sure that the plan rewards those employees who you value the most.

Do I have to include new people that I hire in the future?

Yes. Anyone hired after the plan is in place must be included when they meet the participation requirements.

If I have to include all of my employees, how much money goes into my account?

How much money goes to fund a particular participants benefit depends on how much time each participant has to retirement and the benefit each participant will receive from the plan? The older, more highly paid participants will generally receive a higher percentage of contribution in their accounts.

How much does it all cost?

Contributions to the plan are one part of the costs. Because these contributions are tax-deductible, they are partially offset by the tax savings derived from the plan. Administrative costs will depend on the level of service required for your plan. An average cost to start a 412(i) plan runs between $500–$1,000 for setup fees, then $250- $1,000 annual administration fee for most all 412(i) plans, unless a different amount is agreed upon before the plan is put into effect. These costs are also tax-deductible. Most administrators provide the advisor/agent with all of the necessary documents and agreements which outline these parameters when the plan is adopted.

Who keeps track of all of this every year?

Ultimately, the plan trustees are responsible for making sure the plan complies with IRS and DOL regulations. Because this is a highly technical area, the administrator will keep track of your plan and make sure all the requirements are met.

Do I have to do anything after the plan is in place?

There are a number of things that must be done periodically to ensure that the plan stays compliant with IRS and DOL regulations. Contributions must be recalculated to account for any excess interest which may be credited and for forfeitures. Summary plan descriptions must be provided to plan participants. New participants must be enrolled when they become eligible. A Form 5500 must be filed each year. Terminated participants must be paid any amounts due them. The plan may also require periodic amendments as necessitated by changes in tax law or DOL regulations. A Form 1099R must be given to each participant who is required to recognize taxable income from the plan. Working with a suitable and authorized administrator alleviates the necessity of having someone on staff to do all this.

What happens if my situation changes? Can I change the plan?

412(i) plans do allow some degree of flexibility. The plan can be amended to suit changes in your company's situation. It is recommended that a 412(i) plan be adopted by businesses that expect to have relatively steady earnings for five or more years. The administrator should be available to work with you and your other advisors to make recommendations and follow through with amendments.

Why should I get a 412(i) plan?

A 412(i) plan guarantees retirement benefits. It usually allows higher tax deductible contributions than other types of pension plans. And, very importantly, a 412(i) plan can usually be structured to favor older, more highly compensated employees

Who is the best prospect for this type of plan?

Generally, it will be a firm with 5 or less employees where the owner is at least age 50 and earns a very high, consistent income. The ideal prospect is an independent contractor with no employees. Although, you need to identify the ideal prospect, it needs to be pointed-out that most plans deal with business owners and professionals ages 40 and up. Company sizes range from 1 to 14 for a 412(i) up to as many as 40 employees for a possible "Carve-Out" Plan.

What do I have to do to start a 412(i)?

First you should consult with your tax and/or legal advisors to be certain that a 412(i) plan is right for you.

• Adopt the plan with a Board of Directors resolution
• Sign the necessary documents to establish a plan trust
• Enroll eligible employees
• Make the initial contribution to the plan to fund the benefits
• The authorized administrator should co-ordinate the preparation of all documents

I already have a pension plan. Can I keep that and get a 412(i) plan too?

Yes, you can. There are several ways to do this:

• The existing plan can be frozen and all future contributions made to the 412(i) plan
• The 412(i) plan can be superimposed on top of your present plan and contributions made to both.
• Your present plan can be rolled into the 412(i) plan.

As part of the plan design process, the TPA will determine which of these options is the best suited to your goals and budget for the plan.

I already have a defined benefit plan and my plan administrator tells me that it is fully funded and I can’t make any more contributions. Can a 412(i) plan still work for me?

A 412(i) plan can often unfreeze a fully funded defined benefit plan. Because insurance company guarantees are more conservative than those used by the IRS to determine contributions, 412(i) plans usually require higher contributions to fund the same level of benefits. Because of this, many fully funded defined benefit plans can allow additional contributions to be made when they are amended to comply with the requirements of §412(i).

The following example helps highlight the advantages of a 412(i) design for the business owner looking for the maximum contribution and allocation to the key employee account. Please note that this example is based on a business owner, age 55, income $250,000

Type Of Plan	Allocation	% Of Salary
401(k)	$12,000	4.8%
Profit Sharing	$40,000	16.0%
Money Purchase	$40,000	16.0%
Traditional DB Plan	$107,025	42.8%
Traditional DB Plan with Life	$137,005	54.8%
412(i) DB Plan with Life	$289,833	116%

Each business entity has different rules regarding income. Plan compensation is capped at $200,000.

Contact AMZ Financial Insurance Services, LLC to see if a 412(i) plan would work for your client. Call (866) 279-5677.