By Aaron D. Schindler

Many of your clients may be looking for an efficient way to plan for retirement accumulation with large tax-deductible contributions. In the context of today’s uncertain economy, they also may be looking for a pension that is not dependent on stock market returns and volatility. An I.R.C. 412(i) defined benefit qualified plan may be the solution.

Traditional Qualified Plans Are Limiting

Business owners may find that some qualified retirement plan deferral limits (i.e., 401(k) plans) are too low to meet their retirement needs. In addition, these owners may be ineligible for other tax-advantaged savings strategies such as a SEP, IRA or profit-sharing plan.

412(i) Defined

A 412(i) is a defined benefit qualified plan that is exempt from minimum funding requirements due to the fact that it is funded exclusively with life insurance or annuity contracts or both. The employer defines the benefit that is to be paid to the participant upon retirement, and employer contributions are based on the present value of the promised benefit. Contributions are fully tax-deductible, and assets grow income tax-deferred.

Advantages of a 412(i) Plan

• Higher initial contributions and tax deductions.
• No full funding limitations under ERISA Section 404(a)(1)(A) or current liability testing to limit contributions.
• Guaranteed plan benefits, assuming proper funding. Investment risk is minimized through the safety and guarantees offered by annuity and life insurance contracts.
• Income tax–deferred growth of plan assets.
• Higher retirement values.
• Estate liquidity via life insurance.
• Simple administration.
• No Schedule B.

Ideal Client

The ideal client for a 412(i) plan is a small-business owner, in his 50s or 60s, with few (one to five) employees or no employees. He should expect high and regular free cash flow for the next several years. Generally, this type of person is making more money than he needs to maintain his lifestyle, and would prefer to decrease his income tax liability. As previously mentioned, a business owner may find the deferral limits of other qualified plans inadequate and nonqualified deferred compensation designs inapplicable. Because he is in his 50s or 60s and has a limited number of years to retirement, the 412(i) plan may allow him to make large annual contributions to fund the plan’s payout projections.

The contribution difference between a 412(i) plan and a traditional defined benefit plan can be rather dramatic. For example, a 57-year-old male generating $200,000 of taxable income could make a $240,000 tax-deductible contribution to a traditional defined benefit plan. A 412(i) plan could produce a tax-deductible contribution of $426,000.

For those clients looking to “catch up” on retirement funding due to a late start or stock market-related losses, the 412(i) defined benefit plan deserves a serious look.