412(i) PLANS: WHY SO POPULAR?
WHAT IS A 412(i) PLAN?
A 412(i) plan is a form of defined benefit pension
plan. It’s an employer-sponsored retirement plan that
promises an employee that, upon retirement, he or she
will receive a specific benefit amount annually (or
more frequently) based on a formula that considers compensation,
years of service, or both.
A 412(i) plan (a/k/a a fully insured plan)
is a form of defined benefit pension plan funded exclusively
by life insurance or annuity contracts.
These fully insured plans receive special
treatment under Internal Revenue Code Section 412(i)
– which is why they are called “412(i) plans.”
WHY ARE DEFINED BENEFIT PENSION PLANS
BECOMING SO POPULAR?
Here are some of the many reasons why 412(i) plans may
be of interest to you – or to someone you know:
First, tax law reflects real life.
There’s a pendulum which swings back and forth in synchronization
with the economy and stock market. It is currently swinging
away from the all-out optimistic “go-go” or “everyone’s
getting rich and you can’t lose on stocks” mind set,
and toward a more conservative thinking that emphasizes
certainty and guarantees. What people want most of all
right now is not a return on their investments as much
as a return of their investments. 412(i) plans provide
that security, since, by design and definition, they
are fully insured. Risks are shifted from employers
to state licensed and well financed insurers.
Second, aging baby-boomer business
owners are finding that 412(i) plans favor them as older
and long-service employees.
Third, a 412(i) plan allows significantly
greater contribution levels than a normal defined benefit
plan.
Fourth, 412(i) plans minimize risks.
Because a third party, the insurer, guarantees all benefits,
assuming premiums are paid when due, the employer’s
investment risks are minimized.
Fifth, these plans are generally
easier and less expensive to administer than many other
types of retirement plans. Administration costs can
be significantly lower in a 412(i) plan because there
are no direct actuarial fees and many IRS rules that
other retirement plans must meet.
Sixth, it is relatively easy to calculate
and explain the benefits.
WHAT ARE THE PITFALLS, COSTS, AND DOWNSIDES
OF 412(i) PLANS?
No planning tool or technique is perfect or without
costs or downsides. Here are the main issues:
First, compared to certain other
alternatives, a 412(i) plan is more conservative and
provides less upside potential for growth.
Second, compared to certain other
alternatives, the 412(i) plan provides less investment
and plan design flexibility.
Third, a 412(i) plan is not permitted
to make loans to plan participants.
Fourth, initial costs may be higher
than for noninsured defined benefit plans.
So the clear “upsides” are the use of 412(i)
as a tool for maximizing contributions and guarantees
as well as the simplicity and relative safety.
The clear “downsides” are limited investment
growth potential and plan design flexibility.
WHEN SHOULD A 412(i) PLAN BE CONSIDERED
– AND BY WHOM?
An employer should consider a 412(i) plan if:
- the employer wants to maximize its initial rate
of contribution,
- the employer is in a good current financial condition,
- substantial early funding is preferable for any
reason,
- the firm has no more than 10 employees, or
- contributions to an existing, conventionally funded
defined-benefit plan have been severely reduced by
the tax law restrictions on actuarial assumptions
or by the full funding limitation.
Please feel free to contact us to discuss this or other
concepts that might enhance the financial security of
your business, your family, or aid the charity of your
choice.
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