412(i) plans: trying to see through the smoke and mirrors

[AndyH]

I posted a link to a discussion/analysis of 412(i) plans a few weeks ago. We are looking for more analysis. Can anybody point to any?

We're trying to find a way to see through the smoke and mirrors.

[Guest merlin]

Andy,

The most smoke is with the 415 limit. The interest rates in the insurance/annuity contracts are between 3% and 4%. A lump sum payout could run afoul of the "not

The biggest mirror is with the loads in the policies. The loads/expense charges can absorb up to 40% of the cash value for the first 4-6 years of the contracts. How many clients are told going in that the most they can get out in the event of an early termination of the contract is 60 cents on the dollar?

These plans are plans funded solely by insurance/annuity products. We all know how much difficulty insurance creates in normal plans. Imagine a plan made up of only insurance! Wait til they hire a 50-yearold office manager. Rigidity thy name is 412(i)!

Lastly, one of the main points used to sell these things is that you can get these humongous deductions, and you don't need an actuary standing in your way, wailing about reasonable assumptions and methods. The fact that the plan may still require a 5500 and PBGC filing ( OK,no variable premium, but a filing nontheless) kind of slips by. Also,if the plan is top heavy and the benefit formula doesn't at least produce the minimum accrual, the additional benefit does require an actuarial certification.

I'm not against 412(i) plans per se. They're a tool and the have their place. The problem is that the people selling them are using thesmoke and mirrors, either knowingly or unknowingly. I don't know which is worse.

Hope this helps.

[AndyH]

Yes, that is helpful, and I agree with everything you've said. It is just that we continue to get bombarded by people interested in these, mostly sales people. So people who used to bring us business are now selling 412(i) plans to their clients. Guess who loses out.

I did an internet search and found one that I'm having trouble poking holes in. This one has a variable annuity with presumably dozens of investment choices (not unlike a 401(k) plan with an iinsurance company) . And an insurer guarantees a positive return of, say, 2% no matter what. And I assume that the 2% is the underlying interest assumption. So year 1 and 2 there might be a huge deduction, which later becomes offset if investment experience is positive. And over time I would think that the 415 limit might catch up with the assets if the plan starts at an early enough age.

Besides the commissions, which are not indicated in the proposals that I have seen, how does one shoot down the front loaded deduction with facts if the true ultimate investment return is a huge question mark? And, yes, the top heavy issue is there but I think that is easily satisfied.

[mbozek]

The 414(i) plan is still subject to the 415 benefit limits. Also in a 412(i) plan the employer is still buying LI which has to be removed from the plan with a tax on the cash value unless it is paid as a death benefit. Also the premiums must be paid on the policy due date- there is no 8 1/2 month extension. Finally if the investment experience doesnt live up to the assumptions the plan sponsor will be required to make additional contributions to fund the benefits.

I thought there was a thread on this topic last year including an outline at the ASPA conf. What drives the 414(i) plan is the large deduction which is used to purchase LI. The downside is that the client is paying excessive tax deductible amounts for the LI benefit and may wind up with a bill for additional pension contributions. I also would be wary of a guaranteed return - Dividends are not guaranteed and any guarantee on an ins product is only as good as the party making the promise - remember GICs- Mutual Benefit and Exec. LIfe both had long term guarantees. Q Does a 2% return meet the interest assumptions to fund projected benefits? 412(i) plans are to retirement plans what Dot coms were to the stock market a few years ago.

[AndyH]

Well, I'm the one who posted that outline, and I'm looking for more of the same.

And I agree about the life insurance. But the one that prompted this thread is offered with and without life insurance. Here is it. I have no agenda against the company; I know nothing about it. It it simply came up on a search at google.com.

I find it interesting. Comments?

http://www.vip412i.com/

[david rigby]

2%. OK, but remind the client that excess actual earnings goes to pay for such items as the insurance company's expenses and profit. Those items are emphasized somewhat less in a self-funded plan.

And why does anyone want to pay more just so they can get a larger tax deduction?

[Guest merlin]

I don't think you have to be that explicit. Conceptually these contracts are all heavily front loaded. It's the nature of the beast. The insurance company is willing to pay a lot to get their hands on a big chunk of $. A 1st year commission = to 50-100% of the premium is going to eat up a lot of the cash value. If you're being asked by aclient to review a specific proposal you can either coach the client as to what questions to ask, or you can ask them yourself. Either way you know that the answer will not be favorable. It's only a matter of degree.

Mbozek's point about timing is a good one also. How many clients that you have take advantage of the 8-1/2 month rule? Even if they don't, it's nice to be able to tell them it's there if they need it. Not so with 412(i). And how many clients have you seen implement plan one year wanting to "shoot the moon", only to be on their knees the next year because something unforeseen happened to their business?

[AndyH]

Right, pax, I agree. But the 2% may be the guaranteed return. How do you defend against the claim that the upside may be much higher due to possible dividends, experience, etc. You are fighting an unknown skillfully presented by a sales person.

And since your initial deductions were based on 2%, this can (and is) being sold as the best of both worlds, deductions at 2% with real returns of ?????????

And regarding the 8 1/2 month issue, yes, that is a concern for some clients. But not for others. How many physicians have you run into that wanted to pre-fund their plans before year end. I've seen lots of them.

And, Merlin, yes it is possible to sit down with a client and convince them of your analysis. The problem is that the buyers of these things are not getting to the professional. They are being sold and purchased, not analyzed.

[Guest merlin]

Andy,

As pax points out, the "real" return is meaningless because the client won't see it until the loads expire. Actually, I'm not sure they ever really expire. They just diminish.

If you get this far with your client/prospect and he's still bent on the 412(i), let him go. He deserves what he gets.

[AndyH]

I agree. But it's the referral sources who are buying into this, not prospects. The prospects don't get that far. The brokers see their own retirement future.

And I guess you're right. Let them go as well.

[mbozek]

It still comes down to the basic question of whether the client wants to overpay for LI with tax deductible dollars by 200 percent or more. Anyone can guarantee an investment return of 2% net after taking out all the load charges but is this a valid reason to invest in LI? Investment advisors scoff at LI as a form of investment. I see presentations for business owners based on tax deductible LI all the time. Usually only the LI agent profits from the arrangement. There are some clients who are gullible enough to think that they are getting something for nothing (or saving taxes) by putting LI into a retirement plan or VEBA.

[Guest merlin]

Andy

One last thought. If these are sources that refer you busines, you may be able to score some points with them by pointing out these pitfalls so that they're prepared if a sophisticated client or CPA might try to poke holes in their product (just like we've benn doing all afternoon). If not, then you have no choice but to retreat in the face of a superior enemy force.

[AndyH]

Excellent point. Thank you.