t a time when businesses nationwide are jettisoning defined benefit pension plans in droves because of the prohibitively high cost, a niche of the DB market is thriving: 412(e)(3) plans. Funded with whole life and fixed annuities, the plans are fuelling a healthy demand for DB plans of fewer than 100 participants.
So reports the Boston-based market research firm Cerulli Associates in its second quarter, 2011 edition of the Cerulli Edge. Targeted to highly compensated businesses owners who are either sole principals of their companies or one of a few employees, the plans have become popular among executives who need to catch up on retirement savings.
According to Cerulli, 412(e)(3) plans (formerly 412(i) plans) now account for $51 billion in plan assets. And they are among one of several niche markets that Cerulli views as significant “asset-gathering” opportunities for advisors in the years ahead.
That 412(e) plans are included in the group may come as a surprise to insurance and financial service professionals who in past years backed off the plans because of heightened government scrutiny. Among the “abuses” the IRS has targeted since issuing 412(i)-specific revenue rulings in 2004 are plans that offer life insurance on the principals and none on the rank-and-file or different policy types for the two groups.
Some business have also invited the IRS’ wrath by giving plans participants too much coverage (amounts exceeding the prescribed limits under Revenue Ruling 74-307 or Revenue Ruling 2004-20) or involve policies designed to transfer cash value outside the plan and, thereby, avoid taxes.
But the plans hold much promise for those who are prepared to play by the rules and meet the target profile: owners age 45 and older who enjoy a steady cash flow and revenue stream; are seeking to maximize income tax deductions; and provide a substantial retirement benefit for themselves and (typically) 5 or fewer employees.
A fully insured qualified pension plan, the 412(i) is exempt from the complex IRC Section 412 funding rules that apply to all other defined benefit plans. Upshot: The plans are cheaper and easier to administer than conventional pension plans. (They don’t require, for example, hiring of a high-priced actuary to determine employee contribution amounts and benefits, as the plans are guaranteed by the insurer).
Also, by allowing contributions often three times greater than that for traditional DB plans (and up to six times more than in a defined contribution plan), the plans let an employer “fast-fund” retirement savings.