412i plan problems or 412i problem go on the net for lance wallach or 412i…

412i plan problems or 412i problem go on the net for lance wallach or 412i…

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  1. First it was charitable split dollar, then IRC Section 419A(f)6 welfare benefit plans. Soon
    it could be the 412(i) defined benefit plan. These are hot-button planning issues that are
    under scrutiny from the IRS for abusive practices. Because 412(i) plans are being
    aggressively marketed to agents and brokers, and in turn their clients, advisers should be
    careful. They need to be aware of the proper use of a 412(i) plan and what to watch out
    for when being pitched by their promoters.
    A 412(i) plan is a special type of defined benefit pension plan that is funded entirely
    through annuity or life insurance contracts. It must follow the same qualification rules as
    traditional pension plans, including the limits on retirement and death benefits.
    But unlike a traditional defined benefit plan, which may be based on 5% to 6% annual
    investment returns, the 412(i) plan buys annuities from insurance companies that offer
    guarantees of 2% or 3%. With a 2% or 3% return floor, the 4l2(i) plan allows employers
    to make significantly higher annual tax-deductible contributions for employees. For
    example, a company can contribute $100,000 or more to a 412(i) plan for a 50-year-old
    employee making more than $170,000 a year.
    Who are good candidates to use 412(i) plans? Most often, professionals or business
    owners who want their companies to make large tax-deductible contributions (more than
    the current $40,000 limit for 401(k) or profit-sharing plans). The businesses get a tax
    deduction, and the business owners reduce their salary and taxable income to pay for the
    deduction. A 412(i) can be especially attractive to clients older than 50 who have saved
    little or no money in a qualified plan or IRA. Often, these clients are divorced and have
    big large chunks of earlier retirement plans to former spouses. Or they have taken most of
    their income home every year instead of funding their pension plans. The 412(i) also
    appeals to clients who are interested in big deductions with guaranteed investment
    products like annuities or life insurance.
    There are several problems that can crop up with traditional 412(i) plans, however. They
    include the following:
    Smaller is better. The more employees that an employer has, the less financially viable
    the plan becomes, particularly if the employees are older or highly compensated. Because
    412(i) plans are governed by ERISA, employers are not allowed to discriminate in
    funding them. For example, a 50-year-old owner-employee could have the company
    contribute $100,000 a year on her behalf to a 412(i) plan, but then the company would
    also have to fund 40% more ($40,000) to the plan on behalf of its employees.

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  2. IRS Logo
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    Information For... by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.
    “The guidance targets specific abuses occurring with section 412(i) plans,” stated Assistant Secretary for Tax Policy Pam Olson. “There are many legitimate section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements.”
    “Again and again, we’ve uncovered abusive tax avoidance transactions that game the system to the detriment of those who play by the rules,” said IRS Commissioner Mark W. Everson. “Today’s action sends a strong signal to those taking advantage of certain insurance policies that these abusive schemes must stop.”
    The guidance covers three specific issues. First, a set of new proposed regulations states that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value. Some firms have promoted an arrangement where an employer establishes a section 412(i) plan under which the contributions made to the plan, which are deducted by the employer, are used to purchase a specially designed life insurance contract. Generally, these special policies are made available only to highly compensated employees. The insurance contract is designed so that the cash surrender value is temporarily depressed, so that it is significantly below the premiums paid. The contract is distributed or sold to the employee for the amount of the current cash surrender value during the period the cash surrender value is depressed; however the contract is structured so that the cash surrender value increases significantly after it is transferred to the employee. Use of this springing cash value life insurance gives employers tax deductions for amounts far in excess of what the employee recognizes in income. These regulations, which will be effective for transfers made on or after today, will prevent taxpayers from using artificial devices to understate the value of the contract. A revenue procedure issued today along with the proposed regulations provides a temporary safe harbor for determining fair market value.
    Second, a new revenue ruling states that an employer cannot buy excessive life insurance (i.e., insurance contracts where the death benefits exceed the death benefits provided to the employee’s beneficiaries under the terms of the plan, with the balance of the proceeds reverting to the plan as a return on investment) in order to claim large tax deductions. These arrangements generally will be listed transactions for tax-shelter reporting purposes.
    Third, another new revenue ruling states that a section 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly paid employees.
    Copies of the proposed regulations, the revenue procedure, and the two revenue rulings are attached.
    Related Links:
    Revenue Ruling 2004-20 (PDF 65K)
    Revenue Ruling 2004-21 (PDF 58K)
    Revenue Procedure 2004-16 (PDF 71K)
    Proposed Regulations (PDF 50K)

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