412 (i) plans - pros and cons

[Guest lisbetf]

It's that time of year again where my company is getting a lot of requests for proposals for new DB plans. However, a lot of brokers are also recommending installing a 412(i) plan for bigger deductions. I've looked high and low for a nice concise list of pros and cons of 412(i) plans, but haven't really found anything. It seems the readers of benefitslink.com don't like them very much. Can you tell me why?

[david rigby]

In a nutshell, cost includes built in administrative costs (commissions, etc) that seems pretty high.

[Guest merlin]

412i plans are ususally sold on the basis of two "pros":

1. Huge deductible contributions ( which translates into high commissions for the agent - imagine that).

2. No actuarial certifiation is required because the contribution is fixed by the rates in the insurance/annuity policies that are used to fund the plan.

The cons, which the agent doesn't understand, and probably wouldn't tell the client if he did are:

1.The plan is exempt from 412 but not 415.The policy/annuity rates are in the range of 3%-4%. The minimum interest rate to be used for 415 maximum lump sums is 5%. Could be a problem on distribution.

2. Another problem is the fact that the products are heavily front-loaded for expenses,as mentioned by pax above. These loads can eat up 40% of the contributions in the early years of the plan's existence. Client who deposits $1 million over the first 5 years then wants to terminate the plan and only gets $750k out is probably not going to be a happy camper.

3.In a conventional db plan the sponsor can make his required contribution in his own time frame during the plan year and if necessary up to 8-1/2 months after the end of the plan year to . In a 412i plan the premiums must be paid when due.Almost zero flexibility when it comes to plan changes too.

[FAPInJax]

Another 'little' quirk is that IF the plan is top heavy (almost guaranteed with the size of the plans) then IF the value of the contracts are not sufficient to pay the participant the top heavy lump sum then a side fund must be established. This side fund then requires actuarial certification which the client was trying to avoid in the first place.

[mbozek]

412(i) plans are marketed to small employers for two benefits: greater tax deductions that otherwise permitted under tax law (which may not be available to youger owners whose max 415 benefit will be less than 160k) and opportunity to purchase LI with tax deductible dollars. If 50% of total contributions are used up for non economic benfits to participants is this a worthwhile investment? Remember that tax deduction will not be more than 35% and this rate will decline in future years. At termination of the plan the participant will still have LI as an asset. The question is was this the most efficient way to purchase LI?

[AndyH]

lisbetf, if you or anybody else is interested and is a member of ASPA, there was what I consider to be a reasonably good outline of the pros and cons of 412(i) plans done by Larry Starr who did a session on it at the 10/2002 ASPA national conference. I believe it can be accessed through ASPA's website in the archive section (with difficulty), but if you know anyone who attended the conference they would have access to it through the CD rom that was issued to all attendees.

I did not attend the 412(i) session since there was so much negative joking about the subject that I thought that a session on it would be overkill, but I did review the outline and it is useful.

Here's the link. I don't see any copying restrictions:

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