412(i) Plans Have Allure

For Eligible Boomers

By

For boomers who own a small business and are becoming edgy about not having enough money set aside for their senior years, a little-used retirement option may be the answer. The 412(i) plan is a kind of defined benefit pension plan but without the usual costs and administrative headaches associated with pension plans.

Named after a section of the Internal Revenue Code, a 412(i) plan is exempt from IRS funding rules that apply to other types of defined benefit plans because it is backed by life insurance or annuity contracts.

Benefits are funded using level premiums for all benefits, which continue until the retirement date stated in the plan.

A 412(i) plan is considered appropriate for the owner of a very small business, and top executives who work for him, and for self-employed individuals.

Because it does not have the limitations on tax-deductible contributions that are common to other types of retirement plans, such as 401(k)s, the 412(i) lets the individual set aside the most cash possible for retirement.

“The 412(i) favors people in the 45 to 70 prime age group, where you want a maximum possible tax deduction, and the company has the cash flow to take care of it,” says Keith Baumgarn, vice president of pension sales, Lafayette Life Insurance Company, Lafayette, Ind.

Whether a 412(i) is a solution for a given client depends on the situation, he says.

“We would stress selling the client on doing a feasibility study first to see if its right,” he says. “Use it as a door opener and do a complete study to see if it fits because there are other types of plans that might be a better fit.”

A recent change in the tax laws allows a company to have both a 401(k) plan and a 412(i), so its not an either/or type of decision for the employer or advisor, he points out.

John Oliver, vice president of strategic marketing for Transamerica, Los Angeles, says a prime prospect for the product is the small-business owner in his late 40s through 50s who hasnt had time to build up significant retirement money.

“Theyve been doing a 401(k) but are 10 to 15 years from retirement and need the ability to sock a lot of money away,” Oliver says.

Because a 412(i) is a pension plan, subject to ERISA, it cant discriminate in favor of highly paid executives, “so if you have a lot of older employees, it may not work,” he says.

Although a 412(i) offers big tax deductions, Transamerica doesnt sell it on that basis alone, says Oliver. The company wants its agents to emphasize to clients that it builds a guaranteed retirement income that at some point they can roll over to an IRA or profit-sharing plan.

Agents should look for opportunities to sell it year round, not just as a year-end tax strategy, Oliver says. “You dont have to fund it till you file a tax return, so clients even today [in March] can go ahead and get it started,” he points out.

In fact, right now, when many are still feeling the pain of filing their annual income tax return, clients may be most receptive to the advantages of a 412(i), he notes.

A lot of producers already have the prospects who could fit well with a 412(i), he adds.

“Many of your small business clients may be too small for a 401(k), or if youve gone in to a client who is dealing with buy-sell planning for his business, the 412(i) could be a good fit,” he says.

Oliver warns the product is inappropriate for businesses with more than a few dozen employees. And the client must be willing to commit to making the future contributions, which means his business needs to be doing well enough to meet that obligation for, say, 5 to 10 years in the future.

Dont forget, too, that the IRS is watching for plans designed primarily as a tax strategy, such as those with artificially depressed surrender values for the life insurance portion, Oliver warns.

Bruce Temkin, a consulting actuary with Matthews Benefit Group, St. Petersburg, Fla., says people should put money away while they are making it. Thats the good thing about 412(i)s, he points out. It lets them put a lot of money away.

“How many people are assured that 10 years from now, they will have a comfortable income coming in?” he asks. “Job security is a thing of the past” for many people.

Still, Temkin says he has serious concerns about the way the plans are sometimes sold. “Many advisors could be unaware that should a 412(i) be terminated early, the employer is subject to the same lump-sum distribution rules as in any traditional defined benefit plan.”

This means an individual might be subject to a significant reversion of assets in the fund, which would be taxed at nondeductible 50% excise tax.

To avoid such problems, advisors need to devise exit strategies people might use so they can terminate the plan without penalty, he advises.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 19, 2004. Copyright 2004 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.