Physicians who have maxed outtheir existing pension plans orfailed to save enough for upcomingretirement may want to consider the412(i), a unique catch-up savings vehiclethat appears as though it may have beencreated specifically for them.
The 412(i) savings plan allows physiciansto set aside $100,000, $200,000, ormore annually into a defined-benefitretirement plan. Contributions are tax-deductible,earnings are tax-deferred,and investment risk is comparable to aportfolio of government bonds andTreasury bills, although the latter's prepaymentof principal and interest areguaranteed by the government.
The 412(i) annual contribution ceilingfar exceeds the $41,000 cap on 401(k) andsimilar defined-contribution plans. Asmuch as 10 times that amount can be putaside each year based on the owner's age,number of staff, their ages and incomelevels, and related considerations. Thebest candidates are physicians aged 50 orolder, who are financially stable, are conservativein investment philosophy, andhave six or fewer employees. All full-timestaff must be included in the plan, andonce implemented, the annual contributionis mandatory. Younger physicians canalso utilize a 412(i) to enhance theirretirement portfolios, but the 5-year contributioncommitment tends to discouragethose with inconsistent income.
There has been some negative publicityabout 412(i)s, primarily related tounscrupulous or inexperienced financialplanners and plans with artificiallydepressed values. Recently, the IRS clarifiedthe picture by issuing new guidelinesthat effectively clamp down onabusive transactions, such as excessivelife insurance on participants, leavingintact the basic 412(i) structure, withoutthe shenanigans.
A 412(i) allows physicians to makeexceptionally large contributions. Fundingis through two components: life insuranceand a fixed annuity contract. The former isa straight whole life policy that providesfor a substantial benefit in the event ofthe physician's death during the 5-yearfunding period. The annuity contract paysa meager but guaranteed annual fixedrate, typically about 3%. Annuity guaranteesare based on the underlying insurer'sclaims-paying ability, so choosing a stablecompany is important.
Why should a physician settle for a 3%rate of return on retirement funds whenpotentially higher rates are availablethrough other tax-advantaged plans?Because the 412(i) tax deduction is potentially10 times that of a 401(k), physicianswould have to earn a rate of returnapproximately 10 times higher on their401(k) to equalize it. And unlike equityinvestments in a 401(k), the 412(i) has aminimum guaranteed rate of return.
Of course, there are caveats. The412(i) is a sophisticated strategy thatrequires expert guidance. Needless tosay, investors should heed the new IRSguidelines and avoid 412(i) plans withdisproportionate life insurance; thosecontaining policies with depressed surrendervalues, excessively low cash values,or prescheduled terminations; andthose that discriminate in favor of ownersor highly-paid employees.
Make certain your financial plannerhas significant 412(i) experience, andhave your tax advisor review and sign offon the plan. Inquire as to the reputationand stability of the sponsoring insurer.Finally, make certain the plan complieswith IRS 412(i) codes.
Karl H. Romero, CFP®, CFS, is a
registered principal in Orange
County, Calif, specializing in
financial planning and wealth
management strategies for highnet-
worth individuals, such as
physicians, executives, and business owners. He
welcomes questions or comments from readers