Podcast Center
Video Center
Webcasts
Resource Center
Events
May 04, 2003 at 08:00 PM
Abusive 412(i) Plans Are Tainting Legitimate Programs
By Thomas B. Higgins
Why is it that whenever something “good” starts to become popular some people tinker with it to make it better? Many times, the result is they make it “bad” for all concerned.
This is the situation that confronts those agents who sell 412(i) defined benefit plans.
Two months ago IRS officials made various public comments that they would be looking into certain “abusive” 412(i) schemes that they considered did not pass muster under IRS interpretation. Since then there has been only silence from the IRS officials, while some client advisors have adopted a wait-and-see stance even toward legitimate 412(i) plans. This article will examine the distinction between legitimate programs and the “abusive” aspects under IRS scrutiny.
The key focus is the extraordinary contribution levels claimed as tax deductions under the “abusive” plans. Furthermore, it is how the promoters of these plans make this happen, versus the method used under the more traditional 412(i) plans.
Exhibit 1 provides a look at a typical plan funded 100% with cash value life insurance. A 55-year-old participant adopts a plan with normal retirement at age 65. His defined monthly pension is $10,000, and under the insurance carriers annuity rates it takes $1.7 million at age 65 to guarantee this benefit.
The promoter for this plan has interpreted that this 412(i) program may be funded 100% using an individual life insurance contract. The promoter even has an opinion letter from a large, well-known firm of tax attorneys that states the program he is selling “more than likely” is defensible in gaining the claimed benefits against any IRS objections. In addition, they have covered all the contingent aspects of the program in their 23-page letter and are fairly certain (“more than likely”) that it satisfies all the required IRS Code sections and regulations.
Now, here comes the magic! Because the promoter has interpreted that his proposed 412(i) program may be funded 100% using an individual life insurance contract, he calculates how much face amount must be purchased to get to the guaranteed cash value needed–$1,739,130. The face amount is $8,544,835 for an annual tax-deductible premium of $568,232.
Well, thats an awful lot of life insurance. I suppose if the participant dies, his wife and family will be well taken care of.
But maybe not. The promoter says they only get $1 million because the “incidental limit” in the plan document limits payment of survivor benefits to 100 times the monthly pension. Any “excess” is kept in the plan for funding benefits for other participants, which, in this case, there are none.
Otherwise, the excess death proceeds will revert to the company, be taxed, then paid to the family and then taxed again.
“Not to worry.” the promoter says, just wait five more years and the contracts cash value will grow back to $2,883,690 (with no more premiums paid). The participant would have paid only $630,523 or the tax on that value.