NU Online News Service, May 20, 2004, 6:17 p.m. EDT – A key pension group says the federal government should make all defined benefit plans, including very small 412(i) plans, file annual Form 5500-series tax forms.[@@]
Requiring 412(i) plans with less than $100,000 in assets to file annual tax forms with the Internal Revenue Service would help the IRS maintain the integrity of the 412(i) plan market, according to a group of 5 leaders of the American Society of Pension Actuaries, Arlington, Va.
“Apparently, some promoters of 412(i) plans are encouraging sponsors of owner-only plans to structure their programs so that the value of the insurance products funding the plan never reaches $100,000,” the actuaries write in a letter commenting on IRS efforts to update 412(i) plan regulations.
Some plan sponsors think that avoiding Form 5500 filings can help them “hide” from the IRS and avoid plan audits, the ASPA actuaries write.
The authors of the letter include ASPA Executive Director Brian Graff, the chair of ASPA’s administration relations committee and the 3 co-chairs of ASPA’s government affairs committee.
Section 412(i) of the Internal Revenue Code lets employers use guaranteed life insurance policies and annuity contracts to fund simple defined benefit retirement plans.
Because the sponsors must use funding vehicles that offer guaranteed benefits, the IRS exempts them from some of the recordkeeping requirements and other requirements that it imposes on bigger, more complicated defined benefit plans, including annual Form 5500 filing requirements.
In the 1990s, business owners were more interested in defined contribution plans than defined benefit plans, but 412(i) plans have been getting more attention since the stock market slumped in 2001. Some business owners like the idea of guaranteeing large, steady retirement benefit payments, and owners also have discovered that the low rates of return on guaranteed plan funding vehicles mean that they can deduct huge plan contributions from taxable income.
The IRS has been looking at the 412(i) plan market because of allegations that some companies have been selling overly aggressive life insurance policies, or “sponge policies,” that have an artificially high annual premium and a suppressed cash value in the first several years of the policy’s existence, according to the authors of the ASPA comment letter.
Promoters also design the typical aggressive sponge policy so that the cash value will go up dramatically after the anticipated distribution from the plan to the insured, the ASPA leaders write.
The sponge policies artificially inflate 412(i) plan sponsors’ tax deductions and artificially deflate the amount of taxes that participants pay on the distributions, the ASPA leaders write.
The IRS has proposed a regulation that would affect valuation of life policies in all defined benefit pension plans, not just 412(i) plans.
The ASPA leaders argue that the IRS should explicitly state its intent to prohibit use of sponge policies in the 412(i) market.
The authors of the comment letter also recommend that the IRS come up with a clear-cut way to value the life insurance policies and annuities used to fund 412(i) plans and other defined benefit plans, to ease the worries of legitimate sponsors and keep sponsors of abusive plans from taking advantage of imprecise language.
ASPA has posted the comment letter on the Web at http://www.aspa.org/archivepages/gac/2004/2004-05-18insurance.htm