The current volatile stock market is forcingmany physician-investors to find alternativeways to fund their retirement plans. Inyour search for the right defined-benefit plan foryour practice, have you considered a 412(i) plan?
WHAT IS A 412(i) PLAN?
As long as it complies with the appropriateportions of the Internal RevenueCode (IRC) Section 412(i), this plandoes not have to comply with the often complicatedfunding rules of other planscovered in this IRC section. A 412(i)plan has the following features:
• The only allowable funding vehiclesare group and individual life insuranceand annuity contracts; an insurancecompany must be the contract guarantor.The contracts must be from thesame series and use the same mortalitytables and rate structures for all participants.Variable insurance products arenot suitable because they includeoptions that do not offer guarantees.
• Participants must receive a guaranteedretirement benefit. Premiumsmust be level for all benefits, and paymentscan't extend past a person's retirement date.
• This type of plan typically generates thelargest possible current tax deduction for the businessowner, while simultaneously allowing contributionsin excess of 25% of compensation.
• All employees who work at least 1000 hoursper year and are not covered by a collective bargainingagreement can participate.
The best candidates for a 412(i) plan are practiceswhose owners are at least 50 years old andplan to retire in 5 to 10 years. These practicesshould have fewer than 10 employees, and nomore than 5 or 6 eligible participants. Because theplans are immediately vested and contributions are100% employer-funded, it is unusualfor a 412(i) plan to cover more than 1 or2 nonowner employees. Finally, thereare requirements to make regular contributionsover a period of years, so thebusiness needs to have a steady cashflow to fund and justify the plan.
Traditional plans, such as IRAs and401(k)s, even with catch-up provisions,simply don't allow high enough contributionsto fund a comfortable retirement.Also, many baby boomers havelost faith in the market as a vehicle tohelp meet retirement goals. Fortunately,412(i) plans address these concerns.
HOW DOES IT MEASURE UP?
It's important to recognize the prosand cons of defined-benefit plans. Thefollowing are some 412(i) advantages:
• The plan's assets grow at least atthe minimum contract-guaranteed rate, and maydo better if interest rates start rising again.
• Because the minimum guarantee on manyinsurance products is lower than the current rate ofreturn, higher contributions can be made. Plansmust be funded to the minimum guaranteed levelneeded to generate the retirement benefit specifiedin the plan documents. This can mean significanttax deductions and greater-than-assumed retirementbenefits. Plans can't be over- or underfunded.
• There is no full-funding limitation underthe Employee Retirement Income Security Act,Section 404(a)(1)(A), and no current liabilitytest. No annual actuarial certification is required.Because a board-certified actuary is not neededto ensure plan compliance, this can result inmajor cost savings.
• Participants can view account values and knowwhat their minimum retirement benefits will be.
• Plan assets are often protected from creditors.The following are some disadvantages:
• No loans are allowed.
• Only fully guaranteed life insurance or annuitycontracts may be used. Variable products are notan option. There is no flexibility in investments andno investment direction by participants.
• The required contributions are quite large, sothese plans are only suitable for an established andhighly profitable practice. The owner should bewithin 10 years or so of retirement and be olderthan most of the employees.
• There may be limitations on businessincome tax deductions or the amount of insurancepurchased. An experienced plan administratormust be involved from the outset.
The physician-participant should make at least$200,000 a year, expect their income to continuefor at least 3 to 5 years, and be able to contributehalf their income to the plan. If you have more thana 3-to-1 employee-to-owner ratio, especially if nonowneremployees are highly compensated, the benefitsthe employees accrue may wipe out the 412(i)plan's tax and accumulation advantages.
Ori W. Pagovich, a vice president with the CowanFinancial Group in New York, handles thefinancial planning affairsfor the New York, New Jersey, and Connecticutchapters of the National Association ofResidents and Internsand the American Professional Practice Association.He welcomes questions or commentsat 212-536-8754 or firstname.lastname@example.org.