|
|||||||
| Navigation |
Call Toll-Free
|
|||||||||||||||||
| Recommended Reading | ||||||||
|
||||||||
| See Also | ||||||||
412 (i) Defined Benefits Plans
ERISAzation
412(i) Defined Benefit Plans
Asset protection techniques that are effective should not be overlooked because they are simple or obvious. A simple but very effective technique for business owners is the 412(i) Defined Benefit Plan. A 412(i) plan offers what amounts to a business owner’s asset protection plan that is subsidized by favorable tax treatment. Because the bear markets of 2000-2002 hurt many retirement plans, Congress favors these plans as a means of “making up” lost retirement benefits.
A defined benefit plan is a qualified employer-sponsored retirement plan that provides to the employee a specific retirement benefit amount according to a formula. A 412(i) plan is basically a defined benefit retirement plan that complies with Section 412(i) of the Internal Revenue Code. So long as the plan complies with Section 412(i), it is exempt from the complex funding rules for other plans in Section 412. These plans typically have three features:
-
The Plan is funded solely with individual or group life insurance and/or annuity contracts that are part of the same series and use the same mortality tables and rates for all participants. [Conservative 412(i) plans tend to consist of no more than 50% life insurance and no less than 50% annuity, while some plans will go as high as 67% insurance and 33% annuity. Avoid aggressive plans having in excess of 67% life insurance.]
-
The insurance contracts must fund benefits using level premiums for all benefits. When a participant enters the plan, payments being and may extend no later that the retirement date stated in the plan.
-
Only the insurance contacts can provide the plan benefits, and an insurance company must guarantee these contracts.
-
412(i) Plans can be started late in the tax year but with full tax benefits.
These plans work well for small businesses and self-employed individuals. When properly structured, these plans also protect family and heirs by including an insured death benefit – which further reduces taxable income and increases tax deductions.
Advantages include:
-
Solid creditor protection (discussed more fully below).
-
Maximum current tax deductible contribution for the business.
-
Contributions are based solely on the guarantee provision of the level premium contacts, so there can be no over-funding or under-funding of the plans.
-
There is no full-funding limitation under ERISA section 404(a)(1)(A) or current liability test to limit contributions, and no actuarial certification is required.
-
Unlike traditional defined benefit plans, no quarterly contributions are required and the plan may be funded annually without interest.
-
Typically, the IRS will no challenge the plan assumptions since it is the contact guarantees that govern the required contributions. This permits higher deductions.
Potential disadvantages include:
-
Because of the large required contributions, these plans only work where the business is established and highly profitable. It usually works best where the business owner is within 10 years or so of retirement and is older than most of the firm’s employees, and there are relatively few employees.
-
The Plan should not make policy loans.
-
There is no flexibility in investments, since the Plan is funded entirely with insurance contacts.
-
There may be limitations to the deductions or the amount of insurance that is purchased, and there may be an income component that is re-captured by the business owner.
Creditor Protection
412(i) Plans offer tremendous tax-subsidized creditor protection. Essentially, the business owner is able to move several hundred thousands of dollars out of the business and into an asset-protective structure (the Plan). Essentially, the Plan should be exempt from creditors under the Employee Retirement Income Security Act of 1974 (ERISA). Because the plan is exempt from creditors, the Uniform Fraudulent Transfer Act should not apply to transfers made from the business to the plan (UFTA specifically excludes “exempt” assets). Thus, transfers from the business to the Plan are not susceptible to being set aside by creditors.
Essentially, 412(i) Plans allow business owners to take a deduction for perhaps several hundred thousand dollars out of their business and into the Plan – with favorable tax treatment. For small business owners who are capable of making contributions to these Plans, they are a very effective and efficient method of asset protection. The intelligent use of these plans serves to reduce the financial profile of the business and business owner, while securing additional retirement revenue streams and growing wealth.
Recent E-Mail Exchange on the American Bar Association's RPPT Listserv
-----Original Message-----
Personally, I like deferred compensation arrangements that are protected from ERISA for asset protection. If I can move a couple of hundred thousands dollars out of a business, and thus away from the creditors of the business, for five years, that means that a not insubstantial amount of wealth has been protected, and any tax benefits are just a bonus. 412(i) plans do in fact allow pigs to get fat, but putting one's nose too deep in the 412(i) trough will result in a hog to be slaughtered -- especially as this new (and possibly retroactive in some cases) "guidance" from the Service comes out this month. -- Jay D. Adkisson -----Original Message-----
These plans are viable, legally sanctioned, and highly useful tools where the employer is risk adverse and has the financial stability to maximize its initial rate of contribution, and where contributions to conventionally funded defined benefit plans have been severely reduced by the restrictions on actuarial assumptions or by the full funding limitation. But beware of the pitfalls and draconian (AMONG THESE POTENTIALLY RETROACTIVE DISQUALIFICATION OF THE PLAN) penalties that may be triggered in attempts to overagressively increase the front end tax leverage or enhance benefits directed toward owner-employees or other members of the prohibited group. The IRS has made it clear "it will not be gentle" when it examines illegal Section 412(i) schemes, that "no one should take comfort in the fact that there is no guidance yet", and that "THERE IS A CRIMINAL SIDE" TO SUCH SCHEMES, BEYOND ANY EVENTUAL TAX PENALTIES OR FINES"!
1. Marketing emphasis on scheduled or planned roll-out of the policies
or pre-scheduled termination of the plan Easy LEVEL ONE (MINIMUM HURDLE) solution? Deal ONLY AND DIRECTLY WITH REPUTABLE INSURERS. Easy LEVEL TWO (Next Step) solution? DEMAND - IN WRITING FROM AN OFFICER AT THE HOME OFFICE OF THE ISSUING INSURANCE COMPANY - THAT THE PLAN - IN THE OPINION OF ITS LEGAL DEPARTMENT - COMPLIES WITH CODE SECTION 412(i). Those two very basic steps will quickly shake out the worst of the scammers. Hope this helps! Steve Leimberg |
Combined with Employee Benefit Arrangements
412(i) plans can be used in conjunction with 419 plans and VEBAs to increase employee benefits and maximize the employers deductions. In appropriate cases, through a combination of a 412(i) plan and either a 419 plan or a VEBA, an employer might conservatively take a year-end deduction of up to $500,000 in appropriate cases. As with all tax planning, be sure that your tax attorney reviews these arrangements before participating in them.
| IRS Warns of Abusive 412i Plans IR-2004-21, Feb. 13, 2004 Treasury and IRS Shut Down Abusive WASHINGTON - Today, the Treasury Department and the Internal Revenue Service issued guidance to shut down abusive transactions involving specially designed life insurance policies in retirement plans, section "412(i) plans." The guidance designates certain arrangements as "listed transactions" for tax-shelter reporting purposes. A "section 412(i) plan" is a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires. "The guidance targets specific abuses occurring with section 412(i) plans," stated Assistant Secretary for Tax Policy Pam Olson. "There are many legitimate section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements." "Again and again, we've uncovered abusive tax avoidance transactions that game the system to the detriment of those who play by the rules," said IRS Commissioner Mark W. Everson. "Today's action sends a strong signal to those taking advantage of certain insurance policies that these abusive schemes must stop." The guidance covers three specific issues. First, a set of new proposed regulations states that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value. Some firms have promoted an arrangement where an employer establishes a section 412(i) plan under which the contributions made to the plan, which are deducted by the employer, are used to purchase a specially designed life insurance contract. Generally, these special policies are made available only to highly compensated employees. The insurance contract is designed so that the cash surrender value is temporarily depressed, so that it is significantly below the premiums paid. The contract is distributed or sold to the employee for the amount of the current cash surrender value during the period the cash surrender value is depressed; however the contract is structured so that the cash surrender value increases significantly after it is transferred to the employee. Use of this springing cash value life insurance gives employers tax deductions for amounts far in excess of what the employee recognizes in income. These regulations, which will be effective for transfers made on or after today, will prevent taxpayers from using artificial devices to understate the value of the contract. A revenue procedure issued today along with the proposed regulations provides a temporary safe harbor for determining fair market value. Second, a new revenue ruling states that an employer cannot buy excessive life insurance (i.e., insurance contracts where the death benefits exceed the death benefits provided to the employee's beneficiaries under the terms of the plan, with the balance of the proceeds reverting to the plan as a return on investment) in order to claim large tax deductions. These arrangements generally will be listed transactions for tax-shelter reporting purposes. Third, another new revenue ruling states that a section 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly paid employees. Copies of the proposed regulations, the revenue procedure, and the two revenue rulings are attached. |
Additional Information
Additional information about 412(i) plans and more can be
obtained by calling us
at 866-359-8851.
© 2007 by Adkisson Publishing Inc.. All rights reserved. No portion of this page or any portion of this website may be reprinted or otherwise duplicated without express written permission of Adkisson Publishing Inc.. Legal issues should be faxed to (877) 698-0678.