412(i) - ASPA meeting?

[Guest Keith N]

It sounds like many of you were at the recent ASPA meeting. I did not get a chance to attend. I am sure that many of us (or our clients) have been bombarded by the recent 412(i) mania.

I'm having trouble countering the 412(i) argument with the "It just doesn't smell right". I've tried to understand how the products are designed, but the insurance companies aren't the most forthcoming with "real" information. The agents tend to respond with "well if {insert insurance company name here} is telling us it's ok, it must be ok".

Were there any sessions at ASPA that were particularly good at addressing this? Either pro or con?

[AndyH]

Keith, 412(i) plans were repeatedly ridiculed. There was one session dedicated to them, however, that I did not attend, nor have I yet read the handouts.

Jim Holland made a few remarks such as "if something seems too good to be true, it it probably not true".

He said that these "old ideas" come in circles and seem to reappear in a slightly different form every now and then. He likened 412(i) plans to insurance policies with springing cash values, alluding to potential challenges.

In response to a question about general testing 412(i) plans, he said that if you need an 11(g) amendment, it is probably not a 412(i) plan.

Another time he stressed the need to satisfy the incidental death benefit rules. He also mentioned the business necessity requirements for deductibility under 404.

He said that he has seen insurers advertising that they have legal opinions that their programs are ok. His position is that a plan sponsor needs to get an independent legal opinion. He stressed the word independent.

His overriding theme was caution.

In another session, somebody asked why somebody would put $5 million in one of these only to get $2 million out. The focus of that point was on the fact that the 415 limit is the same as a regular DB plan.

I did not hear one positive comment. Once again, however, there was a dedicated session that I did not attend. Maybe somebody else here did.

[AndyH]

p.s. here is the outline of the 412(i) session

http://aspa.org/archivepages/conferences/2...es/starr-15.pdf

[mbozek]

I recently attended a meeting of financial planners where a speaker extoled the virtues of 412(i) plans over traditional db plans because of the ability to make larger deductible contributions (although he never explained how the funds could be extracted from the plan). The presentation was based on using the excess contributions to buy life insurance. I really do not know why making additional contributions to a 412(i) plan is a selling point if the benefits limits are the same as a regular db plan.

Also the promoters of 412(i) programs frequently market their products through the use of professional journals. The Nov /Dec 2000 edition of Planner publshed by the AICPA had an article by a promoter who stated that the max deduction under a 412(i) plan for a 55 yer old business owner earning 170k would be $146k versus 103.9k for a traditional db plan because the 412(i) plan is funded using the guaranteed rate of the insurance contract which is much lower than the actuarial assumption for the plan. (Part of the reason the rates are so low is that the insurance co must pay a large commission to the agent/promoter.) Can the er get away with excess funding by following the contract terms or is there a legal restriction on the amount that can be deducted?

Since I am not an actuary/accountant I would like some opinion as to whether this kind of funding is permissible and whether an actuary must sign off on the assumptions used or can the employer merely establish the plan, buy the contracts and deduct the contributions required under the contract without any oversight or review by an actuary or accountant.

[Guest merlin]

Except for certain rare circumstances ,412i plans are exempt from the minimum funding standards.There were several threads posted over the spring and summer on this board re the pros and cons of 412i plans.You may wish to check them out.

[AndyH]

Right, and my favorite "pro" by far is that they are actually two retirement plans, one for the client and one for the agent.

But I can't take credit for thinking this up; someone else on this board did. I just like to repeat it.

[mwyatt]

Hey Andy:

That was me, and I still haven't seen anything in the proposals out there to convince me of any other motive. If we were back in the 70's with a 70% marginal rate, maybe you could make some case for pouring money down a hole (amount over what you can withdraw in a lump sum). However, I would have to think that in Jim Holland's example, putting $5m in the pot to get $2m out sounds like one had best restrict 412(i) marketing to the mathematically challenged client;) .

[Guest R. Daestrom]

I've worked closely with several insurance agents, who are really pushing 412(i) plans lately, and I've presented many of the arguments discussed here against 412(i) plans (eg, put $5 mil in, get $2 mil out, etc.). The response I've gotten is that while as an investment vehicle, these plans are not great, the real value, in addition to the large deductible contribution, is the added value of a large, tax-free death benefit, which is a great estate planning tool. Its understood up front with the prospective client (supposedely) that these 2 factors are the real objectives of the plan, not necessarily the accumulation of a large retirement benefit.

I think another reason for their recent surge on the radar screen is that there is at least one insurance company out there that offers first year commissions on 412(i) plans, of over 100% of the contributions received!!! So, even small plans (less than 10 employees) with 1 older individual (presumably the owner) will likely have a deductible contribution of over $100,000, with the agent getting at least that much in first year commissions.

[AndyH]

If the death benefit is tax free, I'd like to know how the PS 58 costs are being computed. If those rates are bogus, they are subject to challenge. That could be an area of added exposure. Ask an agent how PS 58 costs are supposed to be determined and I'll bet in many cases the answer will be "Duh?"

[mbozek]

What is the maximum amt of LI in the plan? As I understand it LI in a DB plan is limited to 100 x the monthly benefit which is maximum of 13,333 or $1,333,300. Can the plan provide for a greater benefit?

I question how great an estate planning tool LI is since the proceeds are considered owned by the employee at death and are included in his gross estate unless paid to a spouse or a charity. Paying the proceeds to the spouse only defers the payment of the estate tax until the spouse's death. Otherwise the LI proceeds will be taxable unless the unified credit amount ($1,000,000 in 2002, 1.5m in 2004 is available). The estate tax rate starts at 41% if the there is no unified credit available.

I really dont think that business owners who adopt a 412(i) program think all the collateral tax and economic consequences through when adopting such a program-- they are only interested in the tax deductions and income tax free LI benefits.

[Guest merlin]

The insurance policies in 412i plans are subject to the usual incidental benefit rules:100x the monthly benefit,or RR 74-307 if the agent is really ambitious.