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Can a traditional defined benefit plan be converted to a 412(i)?


Guest picwrc

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To WDIK: OK so I lied about 8/28 being my last posting. I have just one more thing to say and this really is my last post.

MISSION ACCOMPLISHED!!!!!!!!!!!!

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I agree with WDIK, I don't see how dom gets from point "a" to point "b". Talk about a childish response. Just because you get challanged you take your ball and go home? And what the heck does "Mission Accomplished" mean?

dom, I was very serious in my request for a "real life example" to debate. Isn't that the point of these boards? To debate ideas and concepts?

Your lack of response does nothing but to solidify my position. Apparently you can't come up with anything to offer so you respond like Iraq's previous Information Minister. You can't change opinions by simply spouting your own opinion. You need to present facts so that we can choose to agree or disagree. What is the motto of the Society of Actuaries.... "substitute facts for impressions"

The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

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Hey Blink:

Interesting link. Looks like someone got caught (thanks to Mike Preston). I think the analogy of a house of cards is appropriate with this carve out scenario...

Actually Dom:

After reviewing Blink's link, my only advice is watch your back. You need to...

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  • 3 weeks later...
Guest Pete Swisher

AndyH

There are good reasons to convert to 412i, and (as mentioned previously) bad ones.

I would offer this on the seemingly sensitive issue of the merits of 412i: we humans often tend to strong opinions before we know all the facts. Before becoming a pension geek I was (still am, technically) a CFP/RIA/stockbroker but my start in the business was with MassMutual selling, among other things, life insurance. To ensure I understood what I was selling I ran the numbers: net present value calculations on streams of unequal cash flows, net of tax, to see when life policies were efficient and when not. Few life agents know how to run those numbers or what to compare them to, so I feel like I understand the math better than most.

So:

1. Yes, there are estate planning reasons for 412i. The setup is tricky and aggressive but a trust can own the death benefit of the life policy outside of the plan and outside of the participant's estate. Since pension dollars are very "tax hostile" (subject to Income in Respect of a Decedent as well as estate tax--can be over 80%) this is a tool to move those tax hostile dollars out of the plan (away from IRD) and out of the estate. Similar strategies can be employed in DC plans.

2. The principal advantage of life insurance is its tax treatment, which is moot in a qualified plan, but the "rollout" strategy is therefore crucial--how will the participant get the money out? Just as important, where will the money go? If the annual benefit in retirement will not be spent 100%, then the "rollout" can simply be to distribute portions of cash value which then remain in the policy, and on which all future growth will be tax-free. Not needing the money is thus a good reason to convert.

3. Life policies have a much narrower application from an investment efficiency standpoint than the insurance companies would prefer. When you're a hammer... But they DO have powerful application in financial planning for ordinary folks, not just the wealthy. So "need" is a good reason to convert (life insurance need) but that concept is tricky--includes wishes for family, liquidity, risk tolerance, feelings about likelihood of long life/early death, and (very important) present and future insurability on favorable terms. For those of you who think "buy term and invest the difference" is the only way that "intelligent" people do it, I respectfully submit that you have never done the math and don't understand the human lifecycle (or soul).

4. In the absence of a life insurance need, life insurance is a piss poor investment. Using life insurance to fund 412(i) is probably not the best choice if you have no life need and are just after a big deduction. If any of you have clients that want big deductions just have them call me--I'll be happy to bill them a rapacious fee so they can deduct it.

5. Life insurance is not the only form of insurance--412(i) calls for "insurance contracts" not life insurance. So annuities are an option. I've sold a ton of fixed annuities in the past and believe strongly in them for the right client. If a client is highly conservative, older, wants guarantees, then a fixed annuity can be fantastic in or out of a qualified plan. They can be combined with life insurance where appropriate, and doing so helps water down the death benefit to keep it below the incidental limit.

6. And yet...I've seen a lot of trash illustrations, too. Ridiculous deductions and face amounts, miniscule employee contributions, big red flags crying "please audit me." IRS has already announced its intention to go after abusive 412i's, and the illustrations I'm seeing sure look abusive, but I'm not an administrator or actuary and can't properly speak to that side.

7. And last but not least, the fiduciary issues...don't get me started. Suffice to say I think they are being ignored.

So 412i can be a good thing, but probably a lot less often than its most ardent proponents would prefer--one man's opinion.

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Thank you for your interesting and informative comments. Reasonable people can disagree.

You lost me, however, as a non-skeptic when you stated that you have sold tons of annuities in the past and that they can be a "fantastic" investment in or out of a retirement plan. I could not disagree more.

And, I have nothing against brokers or people who sell insurance. I have close relatives that do. But I think that annuities are usually sold to take advantage of uninformed people.

Just another opinion.

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"But I think that annuities are usually sold to take advantage of uninformed people."

=====================================================

Andy: I COULD NOT AGREE WITH YOU MORE! Does your belief extend to a DB pension plan that compels lifetime annuitizing? Afterall, such a payout scheme is nothing more than purchasing an immediate fixed annuity with the retirement reserve fund.

Peace and Hope,

Joel L. Frank

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Pete: I am very intersted in how a trust can own a LI policy outside of the plan and the participant's estate since retirement benefits must be held for the excluisve benefit of the participants in a qualified trust and be non alienable under IRC 401(a)(13), eg., the participant cannot waive rights to benefits. I have heard many promoters make similar statements but I am unaware that any ruling has ever been issued by the IRS. The problem is that the client's estate, not the client, will pay the estate tax (unless the LI is paid to the spouse). However avoiding estate tax is a poor reason to over pay for a death benefit in a retirement plan with tax deductible dollars since the estate tax will be eliminated for most taxpayers in the next few years. After paying income taxes (with max rates of 35% though 2010) the dollars could be invested in more productive investments such as dividend paying stocks with a max tax of 15% for both dividends and cap gains which is considerably less than the 80% tax on IRD that you used.

mjb

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Guest Pete Swisher

Yikes. Lively topic.

1. With all due respect, if you think all annuities are a ripoff (as two of you imply) you need to study the products and the customers who use them more carefully (with financial calculator in hand).

2. MBozek: every time I jump in on these message boards I seem to tweak the nose of providence by tangling with attorneys or legal issues on which I am not an expert, but...I have worked with a number of estate planning attorneys in the past (for wealthy financial planning clients) and know just enough to be dangerous, and the trick as I understand it is not to own the whole policy outside the plan but for an irrevocable trust to own some of the death benefit. Since the DB is tax free (in excess of policy cash value as reflected by Interpolated Terminal Reserve) due to ongoing PS58 payments, it is permissible for a trust to own it. The problem as with split dollar arrangements is the "rollout"--how do you get the cash out? That involves distributions, and becomes a math game of efficient capital transfer from plan, gifting issues, springing cash value hurdles, etc. Anti-alienation doesn't enter into it (try IRM Defined Benefit Pension vs. US Life Ins Co, No. 95-2029, 4th circuit 1996 for ownership/treatment of death benefits). I'm pretty sure there are some pertinent PLR's but my enthusiasm for research is waning.

3. MBozek again: I can see how it might appear, based on recent tax laws, that client plans should be based on these temporary tax advantages (that are already scheduled to "sunset" or were never permanent to begin with), but I feel very safe saying that this is not the consensus view in the estate/financial planning community.

One thing I very much respect: insurance products are often (perhaps usually) sold in situations where they are not the best choice, to the detriment of the industry. But just because car salesmen are shysters doesn't mean cars are bad. So my (plagiarized) advice to pension practitioners on insurance topics is:

"A little knowledge is a dangerous thing,

Drink deep, or taste not that Pierian Spring."

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I have heard that claim made before but all assets of a qualfied plan must be held for the exclusive benefit of the participants. It is a violation of the exclusive benefit rule for plan assets to be held outside of the plan in an irrevocable trust for the benefit of the heirs of a participant. If the participant dies the proceeds will be paid to the trustee of the plan or the beneficaries as an asset of the participant's estate. I have heard of mysterious PLRS that allow the LI benefits to be held outside of the plan and the participant's estate but no one has ever been able to find a citation. Also a retirement plan is not permitted to make inservice withdrawals of benefits to an active participant prior to normal retirement age. IRS announcement 75-110. My reference to non alienation was to the transfer of assets (li policy) outside of the control of the plan trustee, not to the ability of the participant to designate the beneficary of the death benefits.

mjb

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  • 3 weeks later...
Guest Pete Swisher

Mbozek,

You an implacable and worthy foe. I wish I could figure out how to enable the email response thing so I'd know when someone responds.

Just because a portion of a LI policy's death benefit is held by a "person" (such as a trust, which is a legal person) outside of the plan does not mean that the trust is holding plan assets. Simple example: I buy a life policy in the plan and have an annual PS58 cost of $1,000, paid by ME out of pocket. Who "owns" the death benefit? I do. The plan owns the policy, but my LI beneficiary gets the death benefit, tax free, other than that attributable to ITR. I don't think this is a matter of dispute. Nor is it a matter of dispute that I can purchase a policy from the plan, avoiding the transfer for value rule since I qualify for one of the four or five TFV exceptions. Same thing with a grantor trust--it's just a different "person" paying the PS58 cost or purchasing the policy. There are still plenty of issues to worry about (like rollout), but I'm pretty sure being able to own the DB outside the plan is not one of them.

The irony is I've never sold or recommended a 412i and might never do so--not part of my business. I just think you're wrong and that the age-old enmity against insurance is misplaced if not entirely ill-founded. Next time I see my buddy that does this stuff a lot I'll try to get some citations for you and email them.

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  • 3 months later...

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