Close-Up: 412(i) Plan

Physician's Money Digest, December31 2003, Volume 10, Issue 24

Presented by McNeil, Makers of Tylenol

n.

IRC Section 412(i) Plan: A defined-benefit retirement income program guaranteed with insurance company life insurance and/or annuity contracts. This plan is also known as a fully insured defined-benefit plan.

Sometimes the obvious solutions to life's problems are the ones that we easily overlook. This is also true when it comes to asset protection techniques. Falling into that easy-to-overlook category is the 412(i) defined-benefit plan, which is an asset protection plan for physician–business owners subsidized by favorable tax treatment. Over the past few years, the bear market has hurt many investors' portfolios. These investors are turning to the 412(i) plan as a way to make up some of those lost retirement benefits.

A defined-benefit plan is a qualified employer-sponsored retirement plan that provides employees with a specific retirement benefit amount, which is based on a set formula. Basically, a 412(i) plan is a defined-benefit retirement plan that complies with Section 412(i) of the Internal Revenue Code. It allows contributions to be calculated using the guaranteed cash value and annuity purchase rates of life insurance products.

Growing Popularity

Part of the reason why the 412(i) plan has become so popular is because investors have a different mindset today. They're choosing a more conservative investing approach, one that emphasizes certainty. According to Bay Financial Services, what investors want most of all right now is not a return on their investments, but a return of their investments. Since a 412(i) plan is fully insured, it provides investors with that type of security. Risks are shifted from employers to state-licensed and well-financed insurers.

The 412(i) plan allows for significantly greater contributions than a normal defined-benefit plan. According to 412(i) Plans, Inc, a 55-year-old business owner can deduct $94,551 under a traditional defined-benefit plan. That's more than double the $40,000 maximum deduction allowed in a profit sharing or money-purchase plan. With a 412(i) plan, however, that maximum jumps to $302,038. In addition, the 412(i) plan is considered easier and less expensive to administer than other types of retirement plans. There are no direct actuarial fees or IRS rules that other retirement plans must meet.

Possible Plan Pitfalls

There are, of course, some potential disadvantages to be aware of. For example, because of the large required contributions, the 412(i) plan only works when a physician's practice is highly profitable. It usually works best when a physician-owner is within 10 years of retirement and is older than most of their employees. It also works better in smaller practices, where there are fewer employees.

Compared with other investment alternatives, the 412(i) plan takes a much more conservative approach. As a result, there is less potential for gains. In addition, the 412(i) plan provides less investment and plan design flexibility than other options. The plan is also prohibited from making loans to plan participants, something a 401(k) plan can do.

Given the benefits as well as the potential pitfalls, does a 412(i) plan make sense for you? According to Bay Financial Associates, a 412(i) plan makes sense if:

  • The employer wants to maximize their initial rate of contribution.

The employer is in a solid and comfortable current financial condition.

  • The employer prefers substantial early funding for any reason.

The business has no more than 10 employees.

  • Contributions to an existing conventional defined-benefit plan have been severely reduced by tax law restrictions on actuarial assumptions or by full funding limitations.

No matter what market conditions exist, 412(i) plans can be a solid, viable component of a retirement plan. Many employers with a 401(k) or profit sharing plan that is invested in bonds and stocks are adding a 412(i) plan as their guaranteed investment piece. The reality is that retirement investments should be properly diversified. And if you're going to diversify, why not invest in one of the few guarantees life has to offer?

Pop Quiz

1) Contributions to a 412(i) retirement plan are guaranteed through

  • Stock mutual funds
  • The Power Ball Lottery

2) A 412(i) plan is a type of

  • Defined-benefit plan
  • Money-purchase plan

3) A 412(i) plan usually works best when physician–business owners are retiring in how many years?

  • 5
  • 10

4) The investment approach that 412(i) plans take is generally considered

  • Radical
  • Aggressive

5) A 412(i) plan must adhere to plan participation and anti-discrimination requirements, true or false?

  • False

Answers: 1) a; 2) b; 3) d; 4) c; 5) a.