Academic journal article Journal of Accountancy

The Section 412(i) Retirement Alternative: Hedging against an Uncertain Future

Academic journal article Journal of Accountancy

The Section 412(i) Retirement Alternative: Hedging against an Uncertain Future

Article excerpt

Recent 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 all unity contracts and life insurance. (Define benefit plans pay definitely determinable benefits to an employee over a period of years--usually for life--after retirement.) Section 4120) plans have been around since 7974; in uncertain markers, their guaranteed returns art" enticing.

An employer funds such a plan by making annual deductible contributions for eligible workers; the employees are not taxed on the contributions. The plan then put chases 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. …

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