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limited the effectiveness of 412(i) plans, was repealed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
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
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
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
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
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
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
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
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
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.
assets in my 412(i) plan protected from lawsuits and
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
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.
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
2. Adoption Agreement
3. Summary plan Description (for employees)
4. plan trust instrument
5. I.R.S. Tax Determination Letter
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.
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.
& Farrington, PLLC - Attorneys and Counselors at
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2370 130th Avenue N.E., Suite 103 - Bellevue, Washington 98005
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