412(i) Pension Plans Maximize Tax Deductions
A very hot topic in the industry right now is the 412(i) qualified retirement plan. The reason is, these plans are providing huge tax deductions and huge qualified plan contributions for business owners, while generating very large commissions to agents.
Whats behind the buzz is the subject of this article. Before exploring that, however, lets review what 412(i) plans are and are not.
A 412(i) plan is a defined benefit qualified retirement plan. It is based on section 412(i) of the Internal Revenue Code. The plan must be funded with insurance contracts that are guaranteed by an insurance company.
While such plans are subject to the normal rules of other defined benefit plans, the contributions for older employees can be considerably higher than allowed for in traditional defined benefit plans. This is because the benefits can be funded using the guaranteed interest rates of life and annuity contracts.
The plan participants must make contributions to their 412(i) plans each year–because the life insurance contracts must have level annual premiums.
Now, for what 412(i) plans are not: They are not 419 plans or VEBA (Voluntary Employment Beneficiary Associations) plans, both of which have come under IRS scrutiny.
Who is a potential 412(i) client? In general, small businesses with seven or fewer employees are best suited for these plans, with one- or two- person businesses being ideal. Excellent prospects are high-earning small business owners, doctors and real estate agents who have relatively stable earnings.
Note: Mid-size businesses can benefit from the plans, too. However, the plans are not as attractive for them because contributions to such plans must be made for all employees.
412(i) plans have been around for 40 years, but they fell out of favor when the 1990s bull stock market made defined contribution plans look more attractive, due to the high investment returns they were yielding at the time.
Todays uncertain economy has brought 412(i) plans back into favor, however, and they are now more popular than ever. The benefits they offer–of no risk of principal and guaranteed, secure values–are exactly what business owners are looking for right now.
Whats more, the Economic Growth and Tax Relief Reconciliation Act of 2001 has created the potential for even higher contributions and deductions in all defined benefits plans, including the 412(i) plans. This, too, has helped to make these plans more attractive than ever.
How so? EGTRRA introduced several changes that have combined to boost tax deductions for business owners sponsoring 412(i) plans. The EGTRRA changes include: an increase in the maximum compensation used to determine benefits from $170,000 to $200,000; an increase in the maximum dollar limit for pensions from $140,000 to $160,000; and removal of any reduction on the dollar limit on benefits for participants retiring between age 62 and 65.
Today, 412(i) plans provide clients, especially older clients, the largest contribution to a qualified plan, bar none!
For example, a 55-year-old doctor, using a retirement age of 62, could make a maximum contribution of $41,000 into a traditional profit sharing plan; or a $188,209 maximum contribution into a traditional defined benefit plan. But this doctors maximum contribution into a 412(i) plan could be as much as $332,357. Thus, if the doctor is in a 40% tax bracket, his income tax bill is lower, by over $130,000, due to the 412(i) plan.
Also, in this example, the 412(i) plan provides a contribution that is 710% higher than the profit sharing plan. See the chart on this page for other examples.
The 412(i) plan is very conservative. All asset accumulation rates and retirement benefits are fully guaranteed. This means these plans are safe from stock market fluctuations and not influenced by economic down turns.
The guaranteed rates in the insurance contracts are low (in the example above, for example, they are 4%). However, some policies also generate dividends that can increase the return on the policies for the plan sponsor.
The key selling point is how much income the client is sheltering from taxes. Its the tax leverage that makes these plans sing. Another added benefit is that the life insurance policies purchased in the plan are paid for with pre-tax dollars and provide income-tax-free death benefits to the beneficiaries on the pure death benefit above cash value.
Still another advantage: Waiver of premium can be incorporated to make this a self-completing plan if a disability occurs. How many qualified plans have that option?
A final advantage: Financial advisors can use the plans as a door opener to working with CPAs, since CPAs can easily identify 412(i) potential clients. Right now, most CPAs dont know what a 412(i) plan is. But financial advisors can change that and also help the CPA become a hero to his or her clients, by showing the CPA how 412(i) plans can greatly reduce the taxable income of their clients.
In conclusion, the 412(i) plan can provide maximum qualified plan contributions with large deductions for clients, and in return, provide the agent an entry into working with other advisors, while substantially increasing the agents annual commissions.
, LUTCF, is a general agent for the Guardian Life Insurance Company of America, New York, N.Y., in Northbrook, Ill. His e-mail is Scott_Hunken@glic.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, December 8, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.