412(i) Plans are specific type of pension arrangement that fall under the category of qualified defined benefit plans. The Internal Revenue Service (IRS) created these plans to provide small businesses and self-employed individuals with a method to save for their own retirement and that of their employees. Contributions to these plans can be made using fixed annuities, or a combination of annuities and permanent life insurance policies.
To maintain their qualified and legal status, 412(i) Plans must adhere to certain standards. These include non-discrimination rules and specific eligibility requirements. All employees of the company who are over 20 years of age and have been employed for at least one year must be included in the plan.
The popularity of 412(i) Plans has increased over time due to their reliance on guaranteed investments. When fixed annuities are used to fund the plan, retirement benefits are calculated using the annuity’s guaranteed purchase rate. In cases where life insurance contracts are contributed, benefits are determined based on the guaranteed cash accumulation of the policies.
One significant advantage for small business owners is the ability to make larger dollar amount contributions compared to other qualified plans. These contributions are also tax-deductible, which helps reduce the tax burden for the year in which the contribution is made.
412(i) Plans offer several key benefits. They guarantee a monthly benefit for the account holder and create substantial income tax deductions for employers. Additionally, these plans provide significant death benefits for account holders. These features make 412(i) Plans an attractive option for small businesses looking to attract and retain valuable employees, while also providing guaranteed and fixed benefits at retirement for all employees.
A distinctive feature of 412(i) Plans is that they are exempt from complex funding rules and do not require annual actuarial certifications to prove adequate funding. The guaranteed components of the fixed annuities and life insurance vehicles ensure the solvency of these defined benefit plans. The only requirement to maintain this solvency is for the employer to consistently pay the annual policy or annuity premiums. All necessary guarantees are provided by the life insurance company.
It is important to note that insurance companies supply the guarantees required for the plan, but typically do not manage the 412(i) Plans themselves. Instead, this administration is generally handled by IRS-approved third-party administrators. According to the Pension Protection Act of 2006, additional standards and an alternative designation (412(e)(3)) apply to these plans.
Any excess dividends or interest from annuity policies benefit the employer by crediting future premiums. Similarly, dividends from life insurance contracts are applied to reduce future premiums rather than being distributed to the account holder.
Employers often choose to include life insurance contracts in 412(i) Plans for several reasons. They offer a fully tax-deductible method of providing death benefits to small business owners and employees. When the beneficiary receives this benefit, the face value minus the cash value of the policy’s death benefit is distributed as tax-free income. This life insurance component provides valuable estate liquidity that may be needed after the account holder’s death.
