Help Your Clients Other Advisors Understand 412(i) Plans

Financial advisors should take a leadership role in coordinating their small business owner clients planning team, which typically includes the owners attorney and CPA. Financial advisors add significant value by understanding and helping explain the planning opportunities to their clients other advisors.

Partnering with an advanced sales department from an insurance company may be especially helpful in this process. After all, an advanced sales department typically is staffed with attorneys, CPAs and other financial service professionals. While advanced sales consultants do not actually advise the client, they help producers understand the technical issues involved in their cases and help educate the clients CPA and attorney. This may help eliminate confusion for the business owner and help everyone understand the plan and how the products fit into the plan.

For example, an advanced planning technique gaining in popularity is the 412(i) plan. Many small business owners may have been contacted about 412(i) plans. Financial advisors should take the opportunity to explain the 412(i) concept to the small business owner and his or her advisors, and to explain how the insurance products fit.

A 412(i) plan is a fully insured defined benefit plan. It defines a benefit for the participants and requires contributions sufficient to fund those benefits. Typically, a 412(i) plan is funded with a combination of fixed annuity and fixed life insurance contracts. This permits the employer/plan sponsor to shift the risk of investment to the insurance company. Consequently, such plans are exempt from qualified plan minimum funding rules.

However, 412(i) plans are not exempt from any other rules pertaining to defined benefit pension plans and, therefore, must comply with all other qualified plan rules and regulations. For example, the plan must be implemented for all eligible employees. The business owner cannot pick and choose the participants.

The 412(i) rules require:

Funding exclusively by the purchase of individual insurance contracts. The definition “life insurance contracts” includes life insurance policies and/or annuities. Group policies with the characteristics of individual policies as determined by the Treasury are treated as individual insurance contracts;

Funding by insurance contracts that are level premium from the time a plan participant begins participation in the plan until that participants normal retirement age;

Use of the contracts guarantees in establishing contribution levels. Earnings in excess of the level guaranteed must be used to reduce future contributions to fund plan benefits. The contract guarantees are subject to the claims-paying ability of the issuing insurance company;

Contracts that provide policy benefits equal to the benefits provided by the section 412(i) plan;

Premiums for a plan year must be paid before the contract/policy lapses; and,

Contracts against which no loans or security interest are taken.

A 412(i) plan may appeal to a small business owner for at least the following reasons:

First, the plan is a defined benefit plan, which guarantees a stream of income to the business owner and his or her employees. A renewed focus on guaranteed lifetime income in the wake of the stock market decline might enhance the small business owners interest in this type of plan.

Second, because the plan is fully insured by the insurance carrier, ease of administration may be increased and the costs of administration may be minimized.

Third, assuming that the 412(i) plan is structured properly, contributions to the plan are tax deductible because it is a qualified plan.

Fourth, if the plan is funded with annuity and life insurance contracts, the plan will own a life insurance policy on the business owner. Under certain circumstances, the business owner may later acquire the policy from the plan via distribution or sale. The business owner may then use the policy for other purposes, such as estate planning.

While we do not intend to cover exhaustively all of the potential issues with respect to these plans, financial advisors, attorneys, CPAs and clients should be aware of two major potential problems when evaluating a 412(i) strategy. (See sidebar.)

With information like this, a 412(i) campaign may showcase a financial advisors ability to add value, especially when partnering with an advanced sales department to educate the client and his legal and tax advisors.

Of course, at the end of this discussion, the client may indicate that he or she does not want a defined benefit plan. Perhaps the small business owner cannot commit to the concept of annually funding the plan or perhaps he or she wishes to pick and choose who participates in the plan.

In that case, some type of executive bonus plan using life insurance or a nonqualified deferred compensation plan funded with life insurance may be appropriate.

Perhaps the small business owner says that personal financial and estate planning is really what is necessary. In any case, the small business owner is searching for a solution. Financial advisors may help eliminate confusion and coordinate the planning solution for the small business owner and explain how financial products fit into that solution.

Brett W. Berg, JD, LLM, CLU, ChFC, is director of advanced sales for Nationwide Financial, Columbus, Ohio. His e-mail is bergb@nationwide.com. Richard D. Landsberg, JD, LLM, RFC, APM, is a Senior Advanced Sales Consultant for Nationwide Financial in Columbus, Ohio. His e-mail is landsbr@nationwide.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 15, 2003. Copyright 2003 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.