Keys To 412(i) Plan: Focus On Target Market And Plan Details These plans are for conservative clients, not financial thrill seekers

By Amy C. Bryant

For the right client, 412(i) plans are an outstanding technique.

At the most basic level, they are simple and readily understood. However, dive below the surface and an advisor could drown in the qualified plan rules. The following summarizes some of the larger, more relevant issues that advisors who work in this market will face.

By definition, the 412(i) is simply a qualified defined benefit (DB) plan funded exclusively with fixed annuities and, in some cases, life insurance.

This exclusive funding mechanism is an exception to the general funding requirements under Internal Revenue Code Section 412. This is possible because the guarantees in the contracts drive the more relevant features of a plan, such as contribution amounts. The result is that retirement benefits are guaranteed and market risk is shifted to the insurance carrier.

There is a flip side to this proverbial coin, however. This is that the market average for guarantees is only 2% to 4%.

Given this low market average, it seems fairly obvious that 412(i) plans are for a target market. These are for conservative clients, not financial thrill seekers. Only the faint of heart should apply.

In addition to being conservative, the ideal candidate is a baby boomer who is better served by defined benefit plans that cater to clients with a short accumulation period.

Finally, the ideal candidate owns a small business. In fact, the best 412(i) client is the independent contractor with no employees or one young, underpaid assistant. The planning thrust is to keep the total cost of the plan down to a workable level for the client.

With these plan and market definitions in mind, lets review a few rules that will be instrumental in plan design.

The most pressing rule for the insurance advisor is the incidental benefit rule (IBR). This limits the amount of life insurance that the plan may purchase. Planners use the “50% of Premium” test for 412(i). This name is a bit of a misnomer since the 50% actually can be defined as 66 2/3%. (The Internal Revenue Services logic behind this is beyond the scope of this article and the collective patience of most people.) The IBR limits premium to 50% of the amount that would be necessary for an all-annuity contribution.

Another facet of IBR in defining the amount of life insurance is consideration for later adjustments. Simply put, things change. Salaries are adjusted. Benefits are adjusted. Make certain that policies can adjust accordingly and still comply with IBR.

A frequently asked question is: What happens to the insurance when the client dies? The policy splits into two pieces. The cash surrender value on the date of death is a plan asset and is paid as survivors benefits. All remaining proceeds are death benefit received by the beneficiary income tax-free, assuming insurance costs are paid every year by the participant.

If, however, the participant survives to retirement, the client has several options. The first is to sell or distribute the policy out of the plan. If the policy is sold, the client uses outside funds to complete that purchase. If the policy is distributed, it is considered a taxable distribution from the plan and fully included in the clients gross income in that year of distribution. The second option is to surrender or exchange the policy for an annuity within the plan. Either course of action removes the policy from the plan.

Now, for the issue of longevity. How long does the plan need to be in place before termination? Since these are qualified plans, the client must have the intent of creating a permanent plan. If the IRS finds that there was no intent of permanency, the plan is disqualified and subsequently the deduction is lost retroactively to the inception of the plan. Therefore, the client should commit to contributions from participation until the anticipated retirement date.

But heres a planning tip. If the contribution level is too high initially, consider a lower, targeted contribution until the client is ready for stronger funding. It is always easier to increase, rather than decrease, benefits for the plan.

Finally, a critical issue, when this article was being written, is timing. Dec. 31, 2004, is the deadline to sign plan documents and secure the 2004 deduction. That does not mean the annuity and/or insurance contracts must be issued; it only means that the plan documents, such as the adoption agreement, must be signed by the end of the year. Contracts can be delayed until the next year before the client files tax returns.

In sum, the keys to the 412(i) are to stay within the target market and pay close attention to the details of product and plan design.

Amy C. Bryant, J.D., is advanced marketing counsel for Securian Financial Network, Minneapolis, Minn. Her e-mail address is Amy.Bryant@Securian.com.


Reproduced from National Underwriter Edition, December 3, 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.