THE PROS AND CONS OF A UNIQUE TYPE OF DEFINED BENEFIT PLAN
BY WALTER DASZKOWSKI
Its name is a bit of a mouthful, but an IRC Sec. 412(e)(3) plan is a unique type of defined benefit plan that is funded exclusively by the purchase of life insurance contracts, fixed annuity contracts, or a combination of the two. A fully insured 412(e)(3) defined benefit plan may be a solution for the owner of a small business or professional enterprise who desires a large current tax deduction for contributions and secure guaranteed retirement income. The most likely candidates for a 412(e) plan are small, professional businesses that want to maximize contributions for their owners. They work best for companies that are small, well established, highly profitable and have an older owner and younger employees.
Contributions are, by design, very large in the early years of the plan, and its structure may be less appealing as the number of its participants increases.
A fully insured 412(e)(3) DB plan can provide substantial retirement benefits without market risk.
Because benefits are funded based on the contract guarantees, the 412(e)(3) fully insured DB plan can provide a maximum current tax deductible contribution for the business.
There is no full funding limitation under IRC Section 404(a)(1)(A).
No quarterly contributions are required.
There can be no under-funding because contributions are based on the guaranteed provisions of the level premium contracts.
It requires large contributions that must be made each year.
No policy loans are available.
No flexibility in contribution allocations.
It must be funded exclusively through annuity and life insurance contracts.
Business owners may be concerned about what happens if they have a bad year and cannot keep up with their 412(e)(3) DB plan. If that’s the case, it can be amended to cut back the formula and reduce its contribution obligation. Another option is switching from a fully insured type to a traditional DB plan. And if things are really bad, the plan can be terminated.
Keep in mind that this is a niche defined benefit retirement plan that allows for higher than usual tax deductible contributions—one that’s most suitable for owner only businesses or those having fewer than five employees and wherein the owner is materially older than the employees.
Business owners should consult with a tax professional or attorney to determine whether this is going to be the right choice for them, of course.
Walter Daszkowski, CPA, PFS
Daszkowski, Tompkins, Weg & Carbonella CPA, P.C.
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