412(i) Pension Plans & Defined Benefit Plans
|"An important difference between a traditional defined benefit plan and a 412(i) plan is that because insurance is used to fund the plan, a small business owner can contribute considerably more money to a 412(i) plan than a conventional plan, generating a much higher tax deduction."|
Defined Benefit Plans: Breathing New Life into a Coveted Benefit
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(ARA) - Mention Defined Benefit Plan to most employees and their reaction is "wouldn't that be nice. " Defined benefit plans -- where employers set aside money in a retirement plan that guarantees benefits after a certain number of years of service -- have been in rapid decline for more than a decade.
Why? Ask employers: High cost, complex regulations and actuarial calculations and potential underfunding issues.
Mention the same concept to a small business owner and you can add one further concept to that litany: "Totally out of the question. " In actuality, a Defined Benefit Plan may be one of the most accessible -- and desirable -- benefits for a small business to consider.
What most small business owners don't know is that deep in the Internal Revenue Code is a provision that makes it both cost effective and highly advantageous -- particularly from a tax-planning point of view -- for a small business owner to set up exactly that: A defined benefit plan. The provision has actually been around since 1979, and it's contained in section 412(i) of the IRS code, which is how these plans get their name.
"A 412(i) plan is one of the least understood yet most effective tax-advantaged savings instruments available to a small business owner," says David Gantman, a Minneapolis-based executive and corporate benefits planner and a 412(i) expert. "The beauty of these plans is that they provide all the positives of a traditional defined benefit plan but with fewer of the complicated reporting requirements or the investment risks of a traditional plan."
Good candidates for such plans include surgeons' groups, orthodontists and dentists, manufacturer reps, real estate and mortgage professionals, consultants, board of director members, farmers and private practice professionals.
How do the plans work? Traditional defined benefit plans generally are funded by a sophisticated mix of investments. A 412(i) plan vastly simplifies this process through the use of insurance products -- whole life insurance and annuity contracts -- as the funding mechanism.
"In a 412(i) plan the insurance company accepts the risk of earning too little and living too long," says Mark Zingle, president of Zingle and Associates, a Minneapolis fee-based specialist in 412(i) plan design and. "The use of life insurance and annuities to fund the plan eliminates the need to construct a portfolio using various assets."
Tax considerations are an important consideration for all qualified retirement plans. Within limits, all contributions to a qualified retirement plan are taxed. "An important difference between a traditional defined benefit plan and a 412(i) plan is that because insurance is used to fund the plan, a small business owner can contribute considerably more money to a 412(i) plan than a conventional plan, generating a much higher tax deduction," Gantman says.
This allowance involves several key assumptions concerning the structure of the insurance products used to fund the plan. Because of that, it's also important that the type of insurance and the way the policies or annuity contracts are structured be closely examined by your financial advisor to make sure that the plan steers clear of some recent concerns raised by the IRS about these plans.
For more information, contact David Gantman at (952) 903-2218, or e-mail him at email@example.com.
The 412(i) plan can provide many clients with higher deductions and contributions than virtually any other qualified retirement plan, combined with the highest benefits allowed in a qualified retirement plan. The chart below shows the maximum contributions allowed for four older business owners in three types of qualified retirement plans. The 412(i) plan contribution is significantly higher in all cases. And for the 60 year old, the 412(i) plan contribution is $400,000 higher than the contribution allowed in a profit sharing plan.
Examples of Maximum Contributions and Plan Comparisons, by age:
A 45-year-old who plans to retire at age 62 would be able to invest a maximum of $41,000 in a traditional profit sharing plan, $80,278 in a traditional defined benefit plan and $164,970 in a 412(i) plan.
A 50-year-old who plans to retire at age 62 would be able to invest a maximum of $44,000 in a traditional profit sharing plan, $133,131 in a traditional defined benefit plan and $258,019 in a 412(i) plan.
A 55-year-old who plans to retire at age 62 would be able to invest a maximum of $44,000 in a traditional profit sharing plan, $211,448 in a traditional defined benefit plan and $395,634 in a 412(i) plan.
A 60-year-old who plans to retire at age 62 would be able to invest a maximum of $44,000 in a traditional profit sharing plan, $236,910 in a traditional defined benefit plan and $450,112 in a 412(i) plan.
Scenario 1 Orthodontist
A 55-year-old orthodontist recruits a 33-year-old future partner. The two agree to a deferred buyout using a 412(i) Defined benefit plan. The senior principal agrees to retire as owner at age 62. Prior to taking on the recruit, the practice had revenues of $1.8 million and income before taxes of $675,000.
Annual pension - $128,000 2002 income tax deduction - $379,221 Insured death benefit - $3,310,644 Cash at retirement - $2,001,313
This is a 60-year-old who runs the family farm. Sons will take over the business and hopefully grow through acquisitions. Dad wants to retire in five years on a guaranteed annual sum and he wants guarantees.
Annual pension - $73,500 2002 income tax deduction - $301,613 Insured death benefit - $2,225,512 Cash at retirement - $1,065,217
Heating & Plumbing Contractor
This is a 10-person shop with three part-time people and six younger tradesmen. The owner is 50 but has lost a ton of money in the market and wants to rebuild his retirement account while times are good. They used a normal retirement age of 60 and here was the outcome:
Annual pension - $138,660 2002 income tax deduction - $279,588 Insured death benefit - $2,878,255 Cash at retirement - $2,265,686
Note: This article was submitted by a second party and the contents are subject to our disclaimer.
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