A "Defined Benefit 412(i) plan" is a special type of defined benefit pension plan, with three significant characteristics:
Fully Guaranteed Retirement Benefit
Must be funded with Insurance Contracts
Typically generates largest possible tax deduction
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) attractive.
Business owners, starting a second career, should give consideration to the creation of a 412i 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 tax deductions.
In order for a plan to qualify under Section 412(i), certain requirements must be met:
* The plan must be funded solely with individual or group life insurance and annuity contracts that are part of the same series and use same mortality tables and rate assumptions for all participants.
* Insurance contracts must fund benefits using level premiums for all benefits. Payments begin when a participant enters the plan and may extend no later than the retirement date specified under the plan.
* Plan benefits must be provided only by these contracts and be guaranteed by an insurance company. In effect, the plan is "fully insured."
* Participants may not take loans.
These requirements are easily satisfied using IRS-approved prototype plans, funded by products designed specifically for this marketplace. The Pension Professionals 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 "fully insured" 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:
* No full-funding limitation under ERISA Section 404(a)(1)(A) or current liability test to limit contributions.
* There can be no over-funding.
* There can be no under-funding. Contributions are based solely on the guaranteed provision of the level premium contracts.
* No actuarial certification required.
* Substantial administrative savings through the use of an IRS-approved prototype. Wealth Preservation Strategies can advise on special programs available for very reasonable administrative fees.
* No quarterly contributions are required, unlike a traditional defined benefit plan; the "fully insured" model may be funded annually without having to pay interest.
* The IRS will not challenge the plan assumptions, thus permitting higher deductions. It is the contract guarantees that govern the required contributions.
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:
* No policy loans can be outstanding at year end. This is not normally an issue, as many owners of a small business cannot normally participate in any retirement plan loan program.
* No flexibility in investments. The plan must be funded exclusively through insurance contracts in order for all benefits to be guaranteed.