What is the 412(i) plan?
The 412(i) plan is a defined benefit pension plan established under Section 412(i) of the Internal Revenue Code. It is a prototype, or a custom-designed plan that can be used with any investment grade life insurance or annuity contract. The plan is governed by the Employee Retirement and Income Security Act of 1974 ("ERISA"), the federal act governing the funding, vesting, administration and termination of private pension plans. (29 U.S.C.A §1001 et.seq)

How do recent changes in 412(i) law benefit me?
Recent changes in the law have made the 412(i) plan more popular and more powerful as an estate, tax and retirement planning tool. Effective January 1, 2002, EGTRRA established new defined benefit laws which make 412(i) Defined Benefit plans even more attractive. Section 415(e) of the Internal Revenue Code, which limited the effectiveness of 412(i) plans, was repealed effective December 31, 1999. Section 415(e) required a complicated calculation which limited a participant's ability to fund a 412(i) plan. With a repeal of Section 415(e), a 412(i) plan may now be funded for retirement benefits of up to $160,000 annually. This makes it a far more powerful technique than IRAs, 401(k)'s, or profit-sharing plans for a business owner to plan for retirement while enjoying large immediate income tax deductions.

What are benefits of the 412(i) plan for me and my company?
The 412(i) plan is appropriate for a business owner who would like to take advantage of generous tax deductions available for contributions to defined benefit pension plans. The plan is inexpensive to establish and maintain. Contributions to the plan are income tax-deductible. The plan assets grow income tax-deferred and taxes are paid only when the benefits are distributed at retirement. Think of it this way: for each dollar you contribute to a 412(i) plan, the government funds thirty to forty cents for your retirement through the available tax deduction. While growing income-tax deferred, your plan assets are protected from the claims of your creditors, provided the plan is properly established. In addition, the government permits you to contribute substantially more money to your 412(i) plan than to an IRA, 401(k) or profit-sharing plan. Your plan benefits are fully guaranteed by the life insurance or annuity contract(s) owned by your plan.

Low costs to Implement. We implement custom 412(i) plans and work with an Enrolled Actuary to design them properly. This reduces the annual cost of the plan. Your sole proprietorship, S or C Corporation, family limited partnership (FLP) or family limited liability company (LLC) can adopt the 412(i) defined benefit pension plan. As an added benefit, your 412(i) plan may eliminate estate taxes on an IRA! (See discussion below)

In summary, the benefits of your 412(i) plan are as follows:
1. You receive immediate income tax deductions.
2. Your plan assets grow income tax-deferred.
3. You are permitted to make large plan contributions.
4. Your plan assets are creditor-protected.
5. Your plan might eliminate estate taxes on your IRA.
6. Your plan benefits are fully guaranteed by a major insurance carrier.
7. Your C or S Corp, FLP or LLC can adopt the plan.
8. The plan is insured by the Pension Benefit Guaranty Corporation, a federal agency.
9. Your plan is governed by ERISA and registered with the I.R.S.

How is the 412(i) plan designed?
The 412(i) plan is designed by determining how much annual income you will need at retirement and then calculating the annual contributions which will be required to reach that goal. The U.S. government allows you to plan for $160,000 in annual retirement income. The 412(i) plan permits a tax deduction for contributions which are made to the plan to meet this retirement goal. An Enrolled Actuary designs the plan using your information and your goals to meet your needs.

How does the 412(i) plan affect my employees*?
Since it is governed by ERISA, your 412(i) plan must allow employees to participate in the plan. Depending on the circumstances, some employees can be "carved out" of the plan. Employee benefits are determined by a variety of factors. For example:

1. Employees must be over 21 to participate;
2. Employees must stay with the company for a period of 3 years or 6 years (depending upon the vesting schedule) to become 100% vested in their benefits;
3. Employees might have most of their benefits paid for by Social Security so that their contributions are minimized;
4. Employees must work over 1000 hours each year, and;
5. Employees must not benefit from a union plan.

*Where the business entity is a family C or S Corp, FLP or LLC, "employees" may even be you and your children.

How do I fund my 412(i) plan?
Your 412(i) plan is funded with retirement annuities and investment-grade life insurance contracts. These investment assets make security and simplicity the hallmarks of the 412(i) plan. As an example, indexed annuities or indexed life insurance may allow you as the investor to receive a guaranteed 3% interest on your account or 100% of the annual return of the Standard & Poor's 500 (with a "cap"), whichever is greater. This arrangement protects both your downside and your equity upside. While your retirement benefits are calculated on the guaranteed part of the contract, the historic return on indexed annuities generally exceeds that guaranteed rate, so your returns could exceed the guarantee.

How does the 412(i) plan provide retirement benefits?
The cash surrender value of the insurance contract can be converted into an income stream of up to $160,000 per year for life for each participant.

How does the 412(i) plan provide disability benefits?
Following the onset of a disability the cash value of the insurance contract can provide disability income. Fully-funded, the disability income for each participant can be as high as $13,333 per month for the rest of the participant's life.

How does the 412(i) plan provide income replacement upon a participant's death?
The 412(i) plan, fully-funded, can provide your surviving spouse or children up to $13,333 per month for the rest of their lives.

How may I take distributions from my 412(i) plan?
Before reaching age 59 1/2, you may take penalty-free distributions as long as they are uniform, systematic distributions based upon your life expectancy. A pre-59 1/2 lump sum distribution will trigger a penalty of 10% of the amount distributed (the I.R.C. Section 72(t) penalty), plus applicable income taxes. If you have reached age 70 1/2 and you are retired you must take the required minimum distribution from your plan (the calculated annual planned benefit). If you have reached age 70 1/2 and you are not retired you may defer distributions until your retirement.

If I am already retired, may I contribute to my 412(i) plan?
Yes, if you are already retired or are over age 70, you may contribute to your 412(i) plan for up to five years, under certain circumstances.

Are my 412(i) plan contributions subject to the Alternative Minimum Tax (AMT)?
No. Contributions to your 412(i) plan are not subject to AMT and might lower your overall exposure to AMT. This is a powerful tax saving opportunity.

With a 412(i) plan, can I receive an income tax deduction in excess of my salary?
Yes, you can receive an income tax deduction in excess of your salary. Generally, all types of compensation are used in calculating the formula for determining benefits in a 412(i) plan. This includes: base salary; bonuses; vacation pay; overtime; and any other compensation that meets your definition as the employer. In addition, amounts that you contribute to a 401K plan, a Section 125 ("cafeteria") plan or a Section 127 (education assistance) plan can be used in determining the total allowable contribution you may make to your 412(i) plan.

Are the assets in my 412(i) plan protected from lawsuits and creditors?
Yes, your plan is creditor-protected. A properly drafted 412(i) plan is an ERISA defined benefit pension plan. As such, its assets are fully immune from the claims of creditors. The most notorious, widely publicized example is O. J. Simpson, who enjoys his daily round of golf in Florida and his $25,000 monthly NFL pension benefit, even in the face of an outstanding $30 million civil judgment returned against him in California holding him responsible for the deaths of Nicole Brown Simpson and Ronald Goldman.

Is my private family foundation permitted to adopt my 412(i) plan?
Yes, your family foundation may adopt the 412(i) plan for any employee (e.g., you , your children or any other foundation employees). A non-qualified deferred compensation plan might also be a suitable alternative.

Can I amend my 412(i) plan?
Yes, your plan may be amended. If a plan amendment will result in a significant reduction in the rate of future benefit accruals, the plan administrator must notify all participants, certain beneficiaries, and any union representing plan participants. The required written notice is often referred to as the 204(h) notice. For example, if your plan changes the definition of compensation in a way that would lower benefits, a 204(h) notice is required.

Can I terminate my 412(i) plan?
Yes. As plan sponsor, you may terminate your 412(i) plan as long as the plan document provides for termination. In general, a plan must be fully funded and there must be a bona fide business reason for the plan termination, including: a change of ownership of the business by merger; the liquidation or dissolution of the employer; a change in ownership through sale or transfer; the existence of adverse business conditions; and the adoption of a new plan. Upon termination, plan proceeds may be rolled over into an IRA, tax-deferred.

What documents must be prepared to establish the 412(i) plan?
The documents required to establish your 412(i) plan are:
1. Census
2. Adoption Agreement
3. Summary plan Description (for employees)
4. plan trust instrument
5. I.R.S. Tax Determination Letter

Fair Warning to Advisors, Clients and Prospective Clients:
The 412(i) plan is a legal pension trust instrument that must comply with the Internal Revenue Code as well as with all ERISA and Department of Labor regulations governing these plans. The plan document itself as well as the implementation and administration of the plan must be in strict compliance with these rules. Even where a valid plan document and an I.R.S. tax determination letter are in place, lack of proper legal implementation may result in the disallowance of the deduction and invalidate the plan. It is important that you consult with a competent tax attorney in establishing and administering a 412(i) plan.

If you would like to learn more about the 412(i) plan and whether it is appropriate for your circumstances and goals, please contact us. Our initial consultation with you is offered on a complimentary basis. We look forward to meeting with you.

NOTE: This information is designed to provide a general overview with regard to the subject matter covered and is not state-specific. The authors, publisher and host are not providing legal, accounting or any other advice which purports to be specific to your situation. The contents of this website are believed to be completely reliable. Nevertheless, some material may be affected by changes in the laws or interpretations of such changes since the material was entered on the website. If legal advice or other expert guidance is required, the services of a competent professional in the field of law, accounting, insurance or investments should be sought.

Price & Farrington, PLLC - Attorneys and Counselors at Law
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2370 130th Avenue N.E., Suite 103 - Bellevue, Washington 98005
Phone: 425.451.3583.. Fax: 425.452.0153

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