412(i) plan recordkeeping

[Alan Simpson]

What are the recordkeeping requirements for a 412(i) plan?

It is my understanding that they do not need an actuary to review the funding since the funding is through individual insurance contracts with level annual premiums.

[Guest amfam2]

I used to work for an insurance company which had an active market in 412(i) plans. I believe an actuary is required to calculate the annual premium for deposit into the plan. The 412(i) plan was covered by a formal plan document which contained the plan's benefit formula (usually a certain % of pay x years of service). Our actuaries performed this calculation in order to determine what the premium amount would be each year for each participant in accordance w/the plan's benefit formula.

Once the premium was calculated for each participant, we billed the client. Then when the premium was received, we deposited it into the policy. From an annual reporting standpoint, our company prepared the PBGC annual premium filing, as well as Form 5500 (w/o Schedule B - however each and every year we always received a handful of letters from the IRS requesting Schedule b).

In the event a participant terminated, retired or deceased we paid out the policy and any unvested amount was surrendered and used to offset the employer's premiums for the following year.

[AndyH]

412(i) plans pay PBGC premiums? Seems bizarre if the liability at termination is the vested contract value.

[Ron Snyder]

Alan: What are the recordkeeping requirements for a 412(i) plan?

VG: I believe that the recordkeeping and administration requirements are identical for a 412(i) plan as they are for any other type of defined benefit pensions plan, except that:

(1) The plan is not subject to the minimum funding standards under IRC 412, and

(2) Consequently, the plan is not required to file Schedule B with form 5500.

[FAPInJax]

412i plans are subject to PBGC but ONLY the fixed portion is my understanding. The variable rate portion does not apply.

[AndyH]

Thanks. That looks right. Just curious: what would the PBGCs role be for a 412(i), to step in if both the insurer and sponsor went under? Or just the insurer?

[Ron Snyder]

What would the PBGCs role be for a 412(i), to step in if both the insurer and sponsor went under? Or just the insurer?

The PBGC guarantees covered benefits for participants when a plan becomes unable to pay benefits. In that regard it has recourse against the employer up to 25% of the employer's net worth. The insurance company under a 412(i) plan can only guarantee such benefits as they have received funding for. Therefore if participants have been promised unfunded benefits the employer is liable and if unable to pay the PBGC is liable to the extent the benefits are covered.

[Guest merlin]

Alan-there are someother considerations you should be aware of:

1.The 415 limits still apply to 412(i )plans.The interest rates used in the insurance/annuity policies is usually in the 3-4% range.You have to watch out for the 415 maximum on lump sums.

2.The policies are heavily front- loaded for mortality and expense charges.In the event of an early plan termination the sponsor may only recover 60-70% of his premium outlay.of course he's also gotten the benefit of several years of huge tax deductions.

3.There can be no loans against the policies,so that means no APL provision.If you use a canned document from the 412(i) carrier they've probably already written the plan that way,but if your using your own document,e.g. Corbel,you can't allow loans.

4.I'm not sure,but I think I remember something that says if you have a top heavy plan with a formula that does not produce the top heavy minimum you will have to provide it outside the 412(i) plan and you'll need a Sch. B for that portion.Sounds strange enough to be true.

5.Items 1. an 2. usually combine to dictate a conversion to a conventional db plan somewhere around year 5. The converted plan is proably overfunded and the plan "coasts" on the excess assets until the FFL no longer applies. The client then starts contributing again or terminates the plan.

These plans tend to be very rigid and restrictive,and so don't find much applicability, at least here in the East.But they are another tool that can be very useful in the right situation. the problem is that they are marketed by people who don't have any in-depth understanding of what they're selling and so cannot advise the client properly.But in the right hands in the right situation it can work very nicely.Good luck.

[Guest amfam2]

#5 - I agree that these types of db plans can be considerably more expensive (from an employer's annual contribution standpoint) than conventional db plans.

From a consulting standpoint, I have found these type of plans are best for clients who want to establish a retirement plan which maximizes their annual deduction for qualified plans (in a lot of cases even above & beyond the $40,000 maximum allowable for dc plans). For example, I am working w/a group of lawyers right now who are older and are looking to tuck away as much of their firm's earnings as they legally can......

[Ron Snyder]

Of course Merlin is correct in noting the many concerns, especially the 415 issue. Most of the 412(i) plans I have seen have ignored 415 limits and funded to the contract conversion amount, a clear violation of 415.

Which brings us to amfam2: Adding an insurance policy is possible inside a traditional defined benefit pension plan. Funding a significant amount of premium (1/3 of total contributions) is also doable. And with new DB limits permitting huge contributions, 412(i) plans are pretty much dead, or they should be.

One type of 412(i) plan I have seen proposed would use a gimmick life insurance policy with a low cash value for the first few years. The proposal actually acknowledges that their purpose is to maximum fund for 5 years, basing that funding on the 5th year cash value's being equal to the maximum accrued benefit (determined under the contract's assumptions not limited for 415). After 5 years the plan is terminated and the policy distributed for its then cash surrender value.

Guess what? Voila, the cash surrender magically grows over the next 5 years and the participant can then retire.

BEWARE! This is fraught with problems and has been reported to IRS. Ignoring 415 limits and springing cash values are issues IRS has already addressed and yet there are unscrupulous promoters out there selling these arrangements.

I am working with an existing client who has maintained a defined benefit plan for over 10 years and, with the new limits, is able to make a contribution of more than $500,000 this year. And this is without insurance or 412(i).

[Guest amfam2]

To vebaguru: I agree w/your points overall. Would like to add one point - my understanding is that 412(i)s would always yield higher contribution amounts than under any comparable db plan.

My understanding is that under a traditional db plan, the actuary takes into account employee turnover as well as other actuarial assumptions which, when averaged over the employee group, tends to level out the annual contribution into the plan. Under a 412(i) plan, the actuary looks solely at each individual, no actuarial assumptions are factored in which would average a young employee's premium against an older, longer service employee's premium.

Alas, I could be wrong in this, I'm not an actuary and try not to get any actuary-cooties on me in my everyday working environment.....

[Guest merlin]

amfam2-you are generally correct about the discounting for turnover,mortality,etc.But in the small plan arena,which pretty much equates with the 412(i), the only discount is usually interest There isn't enough of a statistical base to allow for anything else.But the actuary is bound to assume a rate of interest that is reasonble for the long term. I can't speak for anyone else but even in today's environment it would give me a severe case of the shakes (read "actuarial cooties") to use a rate of 3%-4%.

[Ron Snyder]

I agree with you that the maximum under a 412(i) will always be larger than under a DB plan, even a DB with life insurance, so long as contract guaranteed interest rates are lower than current actuarial assumptions.

Watch out for those cooties!

[mwyatt]

Of course the contribution will be higher, your client is funding two retirement plans (his and the agent's;) ).

[AndyH]

A 412(i) plan sounds like the "Hotel California" of retirement plans-you can check in anytime but you can never completely check out.

[Ron Snyder]

Andy-

I loved your description ("Hotel California"), but it's not entirely true. A 412(i) plan can be converted at any time by simple amendment to a regular defined benefit plan. Since benefits cannot exceed 415 anyway, the only potential penalties for getting out are: (1) that contributions might be lower (if the plan was being funded to the maximum), or (2) the insurance products may have tremendous surrender penalties (but that is true whether the plan is converted or not).