412i

[Guest rubaiyat]

Any opinions about using a 412 i to handle the overfunding in a defined benefit plan?

[MGB]

412(i) has nothing to do with being able to make use of overfunding. A fully-insured plan cannot be overfunded. Perhaps your question is whether it is advisable to add over-priced insurance contracts to the plan to use up the overfunding?

[david rigby]

MGB is correct. Insurance is usually able to reduce over-funding in a pension plan, approximately the same way it can reduce over-funding in your wallet.

[Guest rubaiyat]

The question deals with an exsisting defined benitit plan that is currently overfunded. The 2 benificiaries involved want to terminate the plan and are facing an overfuding problem. They want to rollover the funded portion into an IRA and are seeking a way to handle the overfunded portion. They were informed that they can uitilize life insurance (412i) to absorb part of the overfunding. Looking for opinions on the feasibility of this stratergy.

[mwyatt]

Assume your client wants to terminate plan near-term. Then I think what you are proposing is to purchase insurance contracts providing pre-retirement death benefit which will have low (or no) cash surrender value due to commissions so can be distributed to your client with little or no tax consequence. But consider that they now hold these policies individually and are on the hook for (presumably) sizeable future premiums to keep policy in force. I'd run the numbers carefully before proceeding as what you all you may be doing is transferring monies paid to the IRS to the agent's retirement plan, if you know what I mean. Also, the 412i may be a bit of a misnomer as it sounds like your client wants to rollover PVAB to an IRA; in pure 412i will have to convert all assets to insurance/annuity contracts. Again, fees, commissions, and surrender charges can alleviate over funding (but in the same manner as losing most of the assets on internet and telecom stocks).

[Guest merlin]

Are you sure that the plan is overfunded? With poor asset performance,low GATT rates, and increased 415 limits thanks to EGTRRA,a lot of our overfundings have evaporated.

OK,you're still overfunded. Let's see:

1.Apply a variation of mwyatt's solution. This one will make the agent really happy. Apply the overfunding to purchase huge policies on your two principals for similarly huge single premium payments Distribute the policies as part if the pvab.Since they will have little or no cash value you will have made nothing out of something. But be alert to the springing cash value issue.See Announcements 88-51,92-182,and 94-101. And since the policy fa's or premiums may violate the incidental benefit rules the policies must be investments of the trust.If one of your p's dies prior to distribution you're back in the soup.

2.Can you add any family members to the payroll and therefore to the plan to soak up some excess assets?

3.How old are your principals? Will they continue to have earnned income? With the the demise of 415(e) what about a qualified replacement plan? Transfer 25% of the excess to the qrp and revert the remainder. The excise tax is reduced from 50% to 15% (20%x75%),and the income tax is reduced by 25%.It's not a perfect solution, but they've got to be better with this thatn under any insurance- related scenario. Assume a 1,000,000 excess. Transfer 250,000 to qrp, pay 150,000 excise tax and 300,000 income tax (assuming all 750,000 reversion is passed through to two p's at 40% tax rate). That leaves them with 550,000 in hand now. Add back the 250,000 in the qrp that presumably will be allocated to them over the next 4 years (40,000 each plus earnings /year )and they wind up with 800,000.at the end of the day. If you put a million dollars into a 412i plan you'll be lucky to have half that in 4 years.

[actuarysmith]

I have heard of one other approach-

(I won't vouch for its' credibility).

There are one or two business organizations that will "buy" the plan assets at a somewhat discounted value. They turn around and merge the plan with an underfunded plan and create a way for the other sponsor to get a fully funded plan.

This organization makes it money from the "spread" between the discount and whatever they charge the other sponsor of the underfunded plan.

Since there is a steep excise tax on reversion, and then normal income taxes to pay, the sponsor of the overfunded plan ends with much more in their pocket at the end of the day.

Since I honestly don't remember the names of companies (and I hate it when people use this site to advertise), I cannot supply you with any names. Maybe you can ask around.

Good Luck.

P.S. I agree with the earlier comment that suggested that you make sure you really do still have an overfunded plan!

[david rigby]

Back to basics first. If the assets exceed the PV of the benefits, let's make sure we have "used up" the permissible benefits. Can the benefit definition in the plan be increased to use up the surplus? Merlin is correct: make sure the plan is amended to recognize the EGTRRA changes to the 415 limit.

[mwyatt]

merlin: I wasn't proposing that as a solution, only commenting on a proposal that I've heard of before (but felt very uneasy about; if it walks like a duck, talks like a duck... very astute listing of IRS announcements BTW).

Pax: you have a very good point also; between the EGTRRA changes and the carnage in the equity markets, even our pre TEFRA over funded plans can get out now after reallocation with no reversion. Only silver lining in this incredibly dark cloud.

[AndyH]

One of you came up with a great line a while back about a 412(i) plan being two retirement plans-one for the client and one for the agent. I thought that was outstanding; and it fits here.

[Guest merlin]

WRT actuarysmith's comment about buying the surplus,one of my clients was involved in one of these transactions about a year ago. The acquiring firm was Financial Frontiers. They are headquartered in California. The deal revolves around buying the business that sponsors the plan,in this case a medical practice, with the purchase price being a percentage of the overfunding. The overfunded plan is then merged with an underfunded plan as described by actuarysmith.I have always been somewhat skeptical of these deals but this was handled very professionally and the actuary used by Financial Frontiers is a reputable guy. My only concern is that since the price is based on the excess, could IRS deem this an indirect reversion under 4980©(2)? Anyone else share this concern?

[MGB]

YES. This problem with these deals has been brought up numerous times and I expect the IRS to invoke the excise taxes on a "test case" sometime in the future.