Unearth a Benefit Plan for Late Bloomers

Physician's Money Digest, July31 2004, Volume 11, Issue 14

Consider the case of the physician in privatepractice who has done little retirement planning.Now that he's turned age 50, he wantsto make sure that he's not only managing hisincome in a tax efficient manner but also putting asideenough to ensure a comfortable retirement. A 412(i)defined-benefit retirement plan may be a good choice.

Defined Benefit Defined

A 412(i) plan is part of the same alphabet soup ofretirement programs that includes the well-known401(k) plan and lesser known 403(b) plan. While eachof these plans is named for different sections of theInternal Revenue Code, they're all rooted in the samebasic principle: If you put money away and agree notto touch it until retirement, the federal governmentwill not tax the money or its investment returns untilyou take it out. For a middle-aged physician, the412(i) model is attractive for many reasons.

One of its greatest attractions is that it spells outthe retirement income it will generate along with thecontributions required to get there. A 412(i) plan canoffer this certainty because its contributions are usedto buy insurance and annuity products rather thaninvestments, which can fluctuate in value. Because ofthis structure, 412(i) plans can be one of the bestchoices for physicians who want large tax-deductiblecontributions as well as the ability to accumulate significantretirement assets in a short period of time.

On the other hand, 401(k) and 403(b) plans aredefined-contribution plans. The retirement benefitsthey generate are not specified in advance, but arebased on the returns earned on the money depositedin them. In recent years, those investment returns havebeen volatile, forcing a number of people to reconsidertheir retirement plans.

Increased Popularity

Fully insured 412(i) defined-benefit plans havebeen around for some 50 years, but there is growinginterest in them because they allow large tax deductionsnow and assured benefits later. That combinationmakes these plans ideal for business owners andprofessionals in their late 40s or 50s who haven'tsaved a lot for retirement. If they're willing and ableto put away sizable sums now, they can secure a substantialretirement income.

Recent regulatory changes permit a benefit limit ashigh as $165,000 per year starting at age 62.Depending on the individual's age when the account isopened and the specific income level they need whenthey retire, the insurance company will calculate theannual contributions required to generate the bestresults. The interest rate assumptions on this kind ofportfolio are typically very conservative, and thelower the interest rate assumed, the larger the taxdeductiblecontributions will be.

Imperfections Noted

Now that we've discussed the advantages, let'sconsider the drawbacks to the plan. By choosing a412(i) option, a practice owner or physician is givingup the following:

  • Funding flexibility. A practice owner should anticipatestable income because they must make the samelevel of 412(i) contributions for at least 5 or 6 years.
  • Loans. You can't take loans from the plan, as youcan from a 401(k) plan.
  • Investment flexibility. In a 412(i) plan, you can'tsuddenly shift your money into hot stocks or capitalizeon rising interest rates.

p align=justify>Any business structure can implement 412(i)plans. They work best if the business owner is age 40or older and the business has relatively few employees(eg, less than 10 employees) who are significantlyyounger than the employer. These parameters reflectthe fact that 412(i) plans are subject to the same maximumbenefit limitations and top-heavy provisions asother traditional defined-benefit plans.

Sheila Hickey has been working in the field ofretirement planning with the Guardian LifeInsurance Company of America since 1972. Shehas earned a Certified Pension Consultant designationfrom the American Society of PensionActuaries. She welcomes questions or commentsat sheila_hickey@glic.com.