07/ 13/ 2007
by S. Kay Bell
For some small companies, a retirement plan that combines pension payouts and life- insurance protection might be a good fit
Retirement planning is one of the trickiest tasks a small-business owner faces. Your hands are already full ensuring your company thrives. Taking time from that to pick through the various pension possibilities is probably at the bottom of your to-do list.
But down the road, when it’s time for you and your staff to retire, the retirement moves you make now will determine whether your post-career years will be as successful as those days running your company.
So take a few minutes to look at retirement strategies now and be sure to include a 412(i) plan on that examination list.
Plan attractions
The 412(i) plan, named after the section of the Internal Revenue Code that authorizes it, is a defined benefit plan. That means it will provide a fixed amount once you retire.
One of the major appeals of the plan is that it is funded exclusively by individual annuities or a combination of annuities and life-insurance contracts.
Because of the insurance component, a 412(i) can provide fixed, known monthly retirement benefits, life-insurance protection and, relative to other plans, large tax-deductible contributions (in excess of $300,000) that can build a substantial retirement fund in just a few years.
Future payout for beneficiaries is a monthly dollar payment for life, adjusted by interest accrued from the insurance policies or earned from the fixed annuities. Recipients have the option to roll the cash value tax-deferred into other qualified retirement plans or take a permanent life-insurance benefit upon retirement.
Any business, whether C Corporation, S Corporation, partnership or sole proprietorship, can establish a 412(i) plan. Although it can be structured for larger firms, experts say a 412(i) is generally a good plan for small firms, those with 10 or fewer employees. The arrangement also works well for high-income individuals and companies that expect stable future earnings.
Here’s an outline of how it works:
- Your 412(i) plan is designed by you and your plan administrator to meet your company’s benefit and contribution level goals.
- Plan documents are drafted for and executed by you, the employer.
- You make annual contributions into special insurance company contracts to fully guarantee the funding of the plan’s benefits.
- Your company takes an annual tax deduction for the amount of the contribution.
You also will need to meet annually with the third-party administrator, required by law, to update the plan. As with all qualified pension plans, the 412(i) has setup expenses, administration costs and annual IRS filings.
Some potential pitfalls
Because of the large contribution levels, 412(i) plans are not for struggling companies. They work best with established, profitable businesses.
Pension experts also recommend the plans be implemented when the business owner is within 10 years or so of retirement and is older than most of the company’s employees.
Unlike some other pension plans, loans against 412(i) funds are not allowed.
There is no investment flexibility. By law, a 412(i) must be funded entirely with insurance and annuity contracts.
Company deductions also could be limited, as could the amount of insurance purchased, and there may be an income component that is recaptured by the business owner.
IRS eyes
Because of the federal oversight and your fiduciary responsibility for your company’s plan, it’s crucial that you deal with reputable and well-established financial/insurance firms in designing your 412(i) plan.
In 2004, the Internal Revenue Service http://www.irs.gov/retirement/article/0,,id=120449,00.html cracked down on some 412(i) plans that it determined used abusive transactions involving specially designed life-insurance policies.
As in most questionable tax arrangements, the abusers were few and legitimate 412(i) plans are offered by several national companies remain available. But you need to be wary of any marketing pitches that seem too good to be true.
In the wake of the IRS scrutiny, some plan administrators recommend split-funded defined benefit plans utilizing more traditional life-insurance products. That’s the approach of Pension Professionals of Florida, which advocates a hybrid 412 plan that utilizes more traditional whole life-insurance products.
“Although you may not see much, if any, difference in the design aspects we feel it is the best interest of our clients to add the Actuarial Certification Schedule B to each and every plan,” says Bert Cutler, Bertram E. “Bert” Cutler, a principal of the Clearwater, Fla.-based pension advisory firm.
Which route you might take depends, of course, on your company’s specifics. As with all pension planning, discuss your personal and company needs with pension experts and your attorney. And with those counselors at your side, thoroughly examine the benefits of a 412(i) plan for your company versus comparable pension alternatives.
