412(i) Defined Benefit Pension Plan The Hottest, True Leverage Pension Plan of the Times by Paul M. League, CFP Due to improvements to Pension Law beginning in the year 2000, and continuing through 2002 and beyond, all of the benefits of the old Defined Benefit Pension Plan, and substantially none of its' drawbacks (save that there are no loan provisions), are resurrected in the 412(i) Pension Plan, making it perhaps the hottest vehicle for meeting retirement needs, while doing so on a highly cost effective & tax preferential basis. Why would you, as an employer or business owner, want to choose a 412(i) Plan over most any other? For many, and especially following the debacle of ENRON and others, this is exactly what the Doctor ordered...safety, security, and guarantees for employees, in conjunction with reduced corporate taxation, increased tax deductions, and a guaranteed income at retirement. First and foremost, any business entity - including the self-employed - can establish a 412(i) Plan, and, in case you want to cram in that tax deduction for your prior tax year, you can establish the Plan prior to year-end, with the actual funding being delayed until as late as the end of your last extension and the actual filing of your prior yearís tax return. A major drawback with most Qualified Plans, like 401(k) Plans, is that while it is somewhat "sexy" to be able to invest your assets in equities, we all know markets rise and fall, and not always in a positive direction at the time one needs to take retirement distributions. Along with this reality is the inability to write off investment losses in Qualified Plans. With a 412(i) Plan you eliminate investment risk along with the write off of losses in exchange for minimum guarantees. 412(i) Plans can only be funded with qualified Whole Life Insurance ($150,000 guaranteed issue regardless of health history) and/or split between Life Insurance & a Fixed Annuity contract (used to either add diversification and/or when more insurance is needed, but one might not qualify due to a negative health condition or history). Many misunderstand the reasons why 412(i) Plans must be funded only with specially selected Whole Life Insurance and Fixed Annuities, as well as the benefits of using these vehicles as the funding mechanisms. The main advantage lies in their guarantees, with a close second being that by using whole life insurance tax deductible contributions into the Plan increase substantially (over $400,000 more under current inflation adjusted limits). Since such funding products use the low interest assumptions akin to their rather conservative guarantees, and one is funding for a future ìdefined benefitî, the result is that 412(i) Plans generate larger present tax deductions. These larger deductions are especially focused on owner/key employees, and more so than any other available Pension Plan in the market today. Also, if death occurs prior to retirement then a tax free benefit is paid to the beneficiaries, instead of a fully taxable account value of other types of retirement plans, which is of no small significance under existing Estate taxation law. Most significantly, properly designed 412(i) Plans carry with them a separate IRS Letter of Determination, thereby fully answering a common obstacle of asset tax planning strategies, which are what Pension Plans, in part, address; namely, the legitimacy and reliability questions. Tax accountants and lawyers love these Plans for their clientele for this reason alone, not to mention the following added and rather significant monetary and control advantages provided best through a 412(i) Plan: Larger Tax Deductions Than With Any Other Type of Pension Plan - Tax Savings IRS Letter of Determination, With Annual Refilling - Plan Confidence Fully Guaranteed Plan Benefits - Fiduciary Relief Extension of Contributions to Latest Tax Filing Deadline - More Time/Less Funding Pressures All Business Entities Qualify - Easy to Help Most Any Business Owner High Salary Cap of $200,000 (2002) - Largest Available Tax Deduction of Any Pension Plan Tax Deductible Contributions Favor Highest Paid With Most Years of Service - An Owner/Key Employee Bias Greater Flexibility than Traditional Plans No Employee Benefit Formulas or Individual Accounts - Allows for Future Plan Contribution Changes & Ease of Administration Same Asset Protection as Other Pension Plans - Assets 100% Federally Protected Permits Conversions of Over-Funded Defined Benefit Plans into 412(i) Plan Along With Continued, Tax Deductible, Funding Allows for Executive Carve-Outs Under "Comparability Rules" Benefits Can Increase Over Time - Inflation Protection Perfect Vehicle for Absorbing Retained Earnings Typical Vesting - 6 Yr (graded over the first 6 years of an employee's service: 0% yr 1; 20% yr 2; 40% yr 3; 60% yr 4; 80% yr 5; and 100% yr 6+). Employee's are vested in their accrued benefit, which is the present value of their future retirement benefit, often much less than the cash in the annuity and life policy. Non-vested amounts are used to reduce future plan costs or to enhance future benefits; therefore, employee turnover benefits the Plan and the remaining owner/key employees. Flexible Distribution Options - Lump Sum; Life Income; Continued Tax Deferral Typical PS 58 Costs - Returned Tax Free At Point of Distribution (First Dollars Out) Typical Administration/Actuary Fees - Cost Effective So, if you have a desire to increase tax deductible contributions, and skew those contributions to percentages where typically over 85% of the tax deduction inures to the benefit of owner/key employees, rather than rank and file employees, a 412(i) Plan is tailor made for you. The focus then becomes what you get out of the contributions, not the amount of those contributions over the years or over the numbers of participants, remembering that not all employees will stay until retirement. Under these conditions, even borrowing to fund such a Plan is not only justifiable, but also highly sensible in cases where the net tax deduction benefits prove out. That's TRUE LEVERAGE! Typical Plan structures are most suitable where a time frame to retirement is not less than 5-10 years or more depending on age; however, due to Plan flexibility, and specifically the ability to modify the underlying insurance funding vehicle, even shorter time frames can be successfully accommodated. The 412(i) Plan is not, therefore, an "employee benefit plan", but rather an owner/key employee "take control & biased planî, beautifully designed to favor a specific class of employees that are both highly compensated, and with the most years of service. Typically, these are owner/key employees. While this may not appear "politically correct", shouldn't business owners and entrepreneurs really get the lion share of their creations? They have, in addition to their creativity and the company that grew from that, all of their own capital at risk, and all of the responsibility that comes with creating & maintaining jobs for others, which is part and parcel of all business enterprises. A 412(i) Plan, while admittedly largely benefiting owner/key employees, can also benefit rank and file employees if they too stay loyal, long term committed company contributors. In the meantime, choose to get into one of these now, or lose big time! Paul M. League, CFP is the Principal of League Financial & Insurance Services, a privately held company located in Beverly Hills, CA since 1985. League also operates and is a Registered Representative & Investment Advisor Representative with the Beverly Hills Branch Office of Royal Alliance Associates, Inc., Member NASD/SIPC-a SunAmerica/AIG Company. League specializes in wealth creation, preservation, and expansion through both individual and Group benefit programs. MAILING ADDRESS: P.O. Box 7007, Beverly Hills, CA 90212-7007, Phone 1. 310. 277. 3141, www.LeagueFinancial.com / e-mail: Paul@LeagueFinancial.com. Disclaimer and Notes: The material discussed is meant for general illustration or informational purposes only and is not to be construed as investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. You should consult your own tax & legal authorities, as we do not provide tax or legal advice (030102). ©Paul M. League/LFIS. All Rights Reserved