412 (I) Plans Can Get Large Tax Deductions for Your Clients

By Tuttle, Matthew; Wallach, Lance | The National Public Accountant, February 2001 | Go to article overview

412 (I) Plans Can Get Large Tax Deductions for Your Clients


Tuttle, Matthew, Wallach, Lance, The National Public Accountant


Do you have clients who need the maximum allowable tax deduction? Do you know any high-salaried entrepreneurs who are concerned about their retirement? Do any of your clients have over-funded Defined Benefit (DB) plans? If you answered yes to any of these questions, please read on. A unique DB plan called a 412(i) exists that is exempt from the funding requirements of IRG Section 412. 412 (i) plans might be able to restore larger deductions to existing plans, and larger deductions can certainly be created for new plans.

Background

In the past, large deductions were created in DB plans. The ideal prospect was a small professional corporation or even a one participant plan. The actuarial cost method and funding assumptions would allow the creation of large deductions.

Then various legal provisions were enacted that limited the amount of deductions possible for these plans, including:

* Mandated quarterly contributions with penalties for the improper timing or amount

* Penalties on the reversion of excess assets due to plan termination

* A new, full funding limitation substantially reducing deductions

* New mandates that each actuarial assumption he reasonable when standing alone

This combination of smaller deductions, more chance for penalties, and increased risk of attack on plan assumptions caused DB plans to be utilized less frequently. It also caused existing DB plans to terminate.

Then an idea began to emerge. If the funding requirements of the law create these problems, the solution is to utilize a plan that is EXEMPT from these funding requirements. The funding requirements are in Section 412 of the IRC. If a plan meets the requirements of Section 412 (i), it is exempt from the funding rules of 412.

The 412 (i) Plan

A plan qualifies under 412 (i) if all plan benefits are funded and guaranteed by individual level premium insurance company contracts, all premiums are paid, and no loans are allowed.

Funding a DB plan with specially designed and guaranteed insurance and annuity products meets IRC Section 412(i) requirements and eliminates the full funding limits that lower the contribution amount for other DB plans. The results are higher current contributions and, therefore, larger deductions.

Large deductions for 412 (i) plans arise because the plan assumptions dictate large contributions. In a 412 (i), the assumptions are mandated to be the guaranteed rates in the life and annuity contracts used to fund the plan. Because the insurance company guarantees the benefits, the plan is exempt from the funding requirements of the Code. The dividends on the insurance and the excess interest on the annuity are used to reduce the next year's premium. Therefore, the plan does receive credit for all earnings in excess of the guarantees.

Some existing DB plans that are fully or over-funded can be converted to 412 (i)s, therefore allowing the business owner to continue deductions. Plan assets can be transferred to an insurance company that has special insurance contracts that qualify under 412 (i); there is no need to terminate the plan and face possible penalties on reversion of excess assets.

What happens if the business owner had a defined contribution plan? …

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412 (I) Plans Can Get Large Tax Deductions for Your Clients
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