ecent stock market declines have triggered
substantial losses for many retirement plans, leading
clients to rethink investment strategies and life insurance
companies to tout IRC section 412(i) plans as a way to
protect retirement funds. CPAs should review such plans to
advise eligible clients.
HOW DO THEY WORK?
Section 412(i) plans are
defined benefit pension plans guaranteed exclusively by
annuity contracts and life insurance. (Defined benefit plans
pay definitely determinable benefits to an employee over a
period of years—usually for life—after retirement.) Section
412(i) plans have been around since 1974; in uncertain
markets, their guaranteed returns are enticing.
employer funds such a plan by making annual deductible
contributions for eligible workers; the employees are not
taxed on the contributions. The plan then purchases from an
insurance company annuity contracts with a guaranteed return
(generally ranging from 3% to 5%). When a worker retires,
the annuity pays an annual retirement benefit taxable to the
employee. The employer can make additional deductible
contributions to the plan to purchase life insurance on
employees’ lives, to be paid to a designated beneficiary.
BENEFITS AND BURDENS
Even though section 412(i)
plans have a guaranteed positive rate of return on
investment that shifts the risk from the employer/employee
to an insurance company, the guaranteed returns are
relatively low. The trade-off is elimination of the risk of
even lower returns (and possible loss of principal) from
investing in the markets.
An advantage to section
412(i) plans is the cost savings employers receive due to
the administrative ease of calculating annual contribution
amounts. Contributions are calculated using a simple
present-value formula based on the guaranteed rate of
return, the retirement benefit and the number of years until
the employee’s retirement. This eliminates actuarial
expenses to calculate yearly contributions.
WHO SHOULD INVEST?
Owners of high-earning, stable
businesses who want to contribute substantial deductible
amounts to their retirement plans will most likely benefit
from section 412(i) plans. To achieve the maximum tax
benefits, business owners usually should be 50 or older.
Because the nondiscrimination, participation and vesting
rules typical to retirement plans also apply to section
412(i) plans, businesses with fewer than 10 employees
benefit most. (As the number of employees increases, the
total cost of contributions rises and the business owner’s
retirement goals are potentially hindered.)
popularity of section 412(i) plans is forcing many CPAs to
learn more about a provision they hardly ever considered
previously. Section 412(i) plans may allow some clients to
achieve their retirement goals, while significantly
leveraging the deductibility of their contributions and
reducing their investment risk. However, such plans are not
for everyone. Thus, CPAs should become familiar with these
plans to determine whether they suit their clients.
For more information, see the Tax Clinic, edited by Frank
O’Connell, in the September 2003 issue of The Tax Adviser.
—Lesli Laffie, editor
The Tax Adviser
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