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Guest Richard Field

412(i) plan establishment procedures

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Guest Richard Field

Whether you are pro or anti 412(i) plans, the business is coming in the door and a number of issues and questions have arisen that we would appreciate your input on:

1. The advantages / disadvantages of beginning or end of year valuations?

2. Can a 412(i) be established in mid year, i.e. 7/1, and if so, can you utilize compensation for the entire year as opposed to 1/2 year?

3. Can the annuity and or life insurance premiums be paid quarterly?

4. Is anyone aware of a procedural checklist that could be followed in the implementation of a 412(i) plan, i.e. time table of events leading to the completion of the plan's establishment? In essence we are looking for a master checklist that incorporates some of the possible nuances in 412(i) plans for a sales force closing on these cases.

Our objective is to efficiently complete the process of implementation of a plan from beginning to end.

Thanks,

Richard

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I'm afraid that you will find the silence to be deafening on this subject.

Most 412(i) questions here go unanswered; I think most people here are tired of the subject.

There have been some very long back and forth debates on 412(i) plans here and they are pretty one sided, so I think most people are not interested in the subject matter any longer.

I say this only to be helpful. You might want to do a search of some of the older discussions to see if there is information useful to you. Maybe you'll get a useful response, but I tend to doubt it.

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Also-- although you have heard these noises before--purportedly there will l be 4 separate pieces of guidance on 412(i) plans out "shortly" (prior to 6/30?) and that a number of entities touting 412(i) plans will not be happy with what they read.

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1. Not sure if it is relevant for a 412(i) plan, but the usual reasons for choosing a BOY or EOY valuation are related to when information is needed or available, such as asset or compensation.

2. ??

3. Contract terms, probably?

4. No.

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1. Agree with Pax. It is generally a matter of convenience as to which is chosen.

2. Yes, it could be established mid-year, same as any other plan. But you might want to give consideration to having the initial plan year being a full year in order to avoid prorating the limits. My understanding is that the IRS has informally stated that this approach is ok. But I guess I'd want a determination letter if I were going to do this. Probably safest (or at least easiest) to simply prorate for the short year.

3. Yes, if the Ins. company allows it. 412(i) requires "level annual, or more frequent, premium payments..."

4. Not that I'm aware of.

I'll just add this. Ignoring the debate about insurance products, etc. - I have nothing against 412(i) plans. In the right situation, with full disclosure and responsible administration, they can fill a niche and be very valuable for certain select situations. What I do have a problem with is how some of them are sold and marketed, and there are currently companies out there which actively promote some (in my opinion) ridiculous abuses. And I think they will get their wings clipped very shortly, as KJohnson mentions - and about time. I've also seen cases where the CPA making the recommendation to install the plan is licensed as an insurance agent, and receives the commissions. I just can't help myself - such an arrangement makes me feel very uncomfortable.

FWIW, if you are going to have a sales force promoting these plans, I'd be exceptionally careful in any disclosure and signoffs, promotional literature, etc. - whatever you are going to do. I'll climb down off my soapbox now - I try not to stand up here too often, so I'm getting dizzy.

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Doesn't sound too good to me. Now what will these insurance salesmen turn to next (419 has already been hammered)...

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Good article. So focusing on reasons to have a non-abusive 412(i), I can only think of one scenario in which a 412(i) plan would be beneficial and that would be if there was a small company that needed a large deduction this year, but wouldn't need that same level of deductions in future years. The relatively low guaranteed interest rates of the insurance company do provide a higher deduction even if only annuity products are used for funding.

Can anyone think of another reason to have a non-abusive 412(i)?

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Blinky - I can think of at least one other possibility, depending upon what ultimately happens with estate taxes. And I'm no estate planner, so I'll leave it to the experts. Having said that... one of my pet peeves with large amounts of life insurance in a qualified plan is that you subject the entire death benefit to inclusion in the taxable estate, whereas if purchased outside the plan by a trust, estate taxation can generally be avoided. (And anyone who can afford a 412(i) plan can afford the insurance outside the plan!) I don't see this aspect getting much publicity. However, if they (Congress) do away with estate taxation, then even following proper incidental limits, you can still purchase more life insurance in a 412(i) than in a "regular" DB plan. So if you can buy it with tax deductible dollars, and you will be purchasing the life insurance anyway, could be very beneficial. Again, there are a lot of "ifs" there and a very small niche.

As to the issue of not getting deductions as large in future years, I suspect that under the current interest rate environment, at least, annuity interest returns aren't substantially above the guarantees, so your high level of deductions would likely continue for quite some time.

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Guest tonymascia1

Richard,

The design and valuation rules for "regular" DB plans also apply to 412(i) plans.

Paying premiums quarterly for a 412(i) plan is certainly OK. The payment schedules for these plans are more flexible than for regular DB plans.

Two master brokers who market 412(i) plans, Ken Hartstein's Economic Concepts, and Dennis Cunning's Pension professionals of America (both out of the Phoenix, AZ area), have terrific procedural checklists available to financial professionals placing case through them. I am also aware of least American National and Lafayette Life having similar documents available.

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Assuming you're not subject to quarterly contribution requirements, trad DB plans really only face the 8 1/2 month after plan year end deadline to get the money in to satisfy 412 (and in the small plan market, especially with one man plans, the quarterly contribution requirements are academic, as missing them only serves to increase your deductible contribution). I would say premium bills from an insurance company are much more inflexible than a traditional DB plan's funding requirements.

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Guest pension222

The only time that I can imagine recomending a 412(i) plan to someone is if the client really intends to take the benefit as a monthly benefit and not a lump sum. In this case the benefit is fully insured and for sure there will be enough $$ to fund the retirement benefit.

If the client changes his or her mind at retirement this most likely would result in a very large reversion because the accumulated cash to fund the benefit will most likely greatly exceed the maximum lump sum. I suspect that in this case, the memory of past large tax deductions will be forgotten as the client writes the check for the reversion to the IRS.

Above all, remember, a 412(i) plan is just a defined benefit plan funded with insurance and/or annuities. Other than a special mimimum accrual rule and the safe-harbor provision in the 401(a)(4) regulations, there is nothing special about it. A lot of insurance guys however think they have reinvented the wheel.

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It seems simplistic to regard 412(i) plans as being "just a defined benefit plan funded with insurance and/or annuities" although that is what it is. The problem is that "A lot of insurance guys however think they have reinvented the wheel. " and have created exotic plan designs usually based on the use of "springing cash values".

I though that these would have died over 10 years ago when the IRS attacked such things, but I guess some things never go away.

I decided even before then not to sell such plans even if the business was coming in the door as Richard Field puts it. Warnings such as the below are easily found through a simple web search:

http://www.reish.com/publications/article_...m?ARTICLEID=365

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Guest tonymascia1

For a business owner/prinicipal whose primary economic concern is tax minimization, 412(i) Plans fit the bill. Business will continue to come in the door; let's make sure "the walk-ins" don't get a booby prize.

Today's cash value insurance policies, designed for 412(i) Plans and IRA/Pension "Rescue" strategies, are less severe than the policies that resulted in RR 89-25. The IRS is still unhappy; most of the "cutting edge" 412(i) case designers are now telling prospects and clients the Interpolated Policy Reserve (funding reserve) of these policies represents true market value, rather than the cash value.

Bruce Ashton, the author of the article GBurns sites in his post, has stated (elsewhere) the IRS has a concern regarding certain 412(i) designs, even greater than low initial cash value policies, which may spoil the party. There are some plan marketers who interpret the "incidental death benefit" rules and regs as pertaining to PAYOUTS, and NOT FUNDING. From this, you see life policies with face amounts of $9 million, $10 million, or more within these "uniquely interpreted" 412(i) Plans. The plan, upon participant's death pays out a maximum of 100 times the monthly Normal Retirement Benefit, with the remaining $$$ staying in the plan.

Greater minds can debate the legitimacy of the above issue. If the ONLY thing the business principal really cares about is tax reduction, with fixed rates of return and insurance protection as just icing on the cake, the case for this particular plan design may be compelling. Otherwise, it's just bad economics, and a "plain vanilla" 412(i) plan will produce better rates of return while safely flying under the IRS radar.

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