412(i) Plan combined with DC Plan

[Guest elem]

I have had a lot of sales guys ask me recently if it is possible to put in a 412(i) plan combined with a DC plan. I assume that it is possible, I'm just not sure what the potential issues would be concerning cross-testing for the two plans.

Assuming that cross testing is possible with this arrangement, and that all employees are in both plans, how does the overall 25% of compensation deduction limit apply? If the 412(i) contribution exceeds 25% of comp by itself, does that mean that any contribution to a DC plan would not be deductible? Or is there some exclusion for 412(i) plans?

[Blinky the 3-eyed Fish]

It is possible to combine the two. You avoid potential issues if the participants are the same in both plans.

404(a)(7) still applies if you have common participants in both plans, so that does mean in your question that the DC contribution would not be deductible.

Sales guys and 412(i) equals big trouble. Ask yourself why a 412(i) would be necessary, especially if you are already at a 404(a)(7) limit. Chances are that it is not.

[Belgarath]

Just some general thoughts...

First, the combined plan deduction limits under IRC 404 do apply.

Second, I can't imagine why anyone would want a 412(i) plan unless their deduction for the 412(i) was going to exceed 25% anyway, so in that case, the DC is nondeductible anyway. But maybe some of the design gurus here can give you a reason why this would be desirable.

Finally, if they are going to install a 401(k) DEFERRAL ONLY plan in conjunction with the DB, then this would be ok.

[Guest elem]

Yes, this is a dumb idea. I would like to talk sales guy out of this idea based on the fact that the whole idea behind the 412(i) is to maximize deductibility, and a combined plan of this type would limit deductibility to 25%. Thanks for confirming that.

I'm sure that sales guy will want to consider a combined plan where no participant participates in both plans. In this case, what would the annual accrual be for the 412(i) plan for 401(a)4 testing purposes? Is it the change in cash value? The Premium?

[Belgarath]

Sorry, but that's not what I said. I said the combined plan limits would apply. That means that the deductible amount would be the GREATER of 25% or the DB cost. (See IRC 404(a)(7)) So your deductibility isn't necessarily limited to 25%.

[SoCalActuary]

With separated plans, can you get each plan to pass 401a4 on its own?

A safe-harbor 412i design that passes 70% coverage won't care about testing.

Also, don't forget your gateway issues if you have both plans. Will you use 7.5% DC minimum contribution? Will you have primarily defined benefit plan?

In general the 412i is defined to have an accrued benefit based on the cash value of the policy. However, you must normalize the accrued benefit for testing, presumably using the plan's actuarial equivalence assumptions. Thus, you would take the beginning cash value, project to testing age on the plan interest rate and divide by the plan's APR to get the beginning accrued benefit. You follow the same procedure with the ending cash value, which is one year closer to testing age, giving you the ending accrued benefit. The difference between is used for the annual accrual test.

I would hope that this potential 412i is not trying to operate without an actuary familiar with these issues.

[Blinky the 3-eyed Fish]

In this case, what would the annual accrual be for the 412(i) plan for 401(a)4 testing purposes?  Is it the change in cash value? The Premium?

I think it depends on how your document is defined. While CSV is generally the normal method of defined the increase in benefit, the plan's definition of the AB which was used to generate the premium and the CSV can work too. I specifically asked this question of Jim Holland during his and Bruce Ashton's 412(i) webcast in early 2004.

[Guest elem]

Sorry for twisting your words. I meant to say thanks for confirming what I thought about the deductibility for both plans combined. You have raised an interesting point. If the DC plan contributions are relatively low, maybe this is not such a dumb idea. Not that a 412(i) plan is ever a good idea, but if the owner can get a contribution/deduction of say $100k, while making a non-deductible contribution to the DC plan of say $10k, maybe its not such a bad thing. Assuming of course that this would pass 401(a)4 testing.

[Guest elem]

Blinky,

It seems to me that using the plans definition of AB for testing would make the most sense. This eliminates possible problems based on the mechanics of the insurance policy that will likely generate inconsistent growth in cash value.

Is there any source other than Jim Holland's verbal that this is acceptable?

[Blinky the 3-eyed Fish]

No, but more importantly there is nothing that says it is not proper. 411(b)(1)(F) is sometimes misinterpreted as the only way to define a 412(i) AB when it in fact is just one way.

[AndyH]

I would hope that this potential 412i is not trying to operate without an actuary familiar with these issues.

That is exactly how sales guys sell these things. Actuaries aren't needed. And now a days cross testing is as easy as pushing a button, right. Just hope the sales guys don't learn the term flip flop funding. That would be slick and shiny.

[Guest pension222]

The popular plan combination among the sales folks today is to put some of the employees in the 412(i) plan, usually the older owners, and everyone else in a profit sharing plan. This "maximizes" the deduction on behalf of the owners and reduces the cost for everyone else.

Of course this opens up a can of worms that the sales folks know nothing about, namely that the two plans most likely need to be combined for 401(a)(4) and 410(b) testing and that at this level neither of the plans is a safe harbor design and then, well, how do you general test a 412(i) plan? I've seen a general information letter from the IRS regarding this question that basically says that they are not going to tell you how to do this.

Incidentially, the same general information letter says that a 412(i) plan funded with a combination of life insurance and annuities, cannot qualify as a safe harbor design under 1.401(a)(4)-3(b)(5) because 1.401(a)(4)-3(b)(5)(vii) says that all benefits must be funded through contracts of the same series and because of the inherent differences between insurance and annuities, they cannot be of the same series. If the conculsions of this letter are correct it means that ANY 412(i) plan funded with insurance and annuities must be general tested.

[Guest flogger]

At the Washington DC ASPPA meeting the session on 412(i) Plans mentioned the requirement that the insurance and the annuities must be part of the same series of policies. Apparently there is (are) a product that is a combination life ins/annuities that is all one series, and was designed for this purpose (412(i)). I believe the product it's a Guardian product, but I don't know anything about its particulars.

[GBurns]

Does anyone have anything definitive as to what "same series" means? I tried some time ago to get an answer from Guardian etc but got nothing worthwhile.

[Belgarath]

I don't think there is anything definitive. I've always assumed that the important thing is that the settlement rates are identical - that is, every 1,000 in the cash value at retirement in both the insurance and the annuity purchases exactly the same monthly lifetime benefit, and that all the life policies must have identical terms, and all the annuity policies have identical terms. (other than a permissible switch between carriers) This would make it very difficult, if not impossible, to have policies from different companies issued simultaneously, as the odds of the policies between companies being identical are slim. As far as the assertion that if there are both life and annuity policies the safe harbor can't be satisfied, I happen to disagree with that statement - even taking a charitable view of the IRS statements, I think at best they are stretching form over substance to an extreme degree.

[Guest SaulAlbom]

Sorry for the simple questions guys. I'm a sales guy and I want to understand this stuff.

"Sorry, but that's not what I said. I said the combined plan limits would apply. That means that the deductible amount would be the GREATER of 25% or the DB cost. (See IRC 404(a)(7)) So your deductibility isn't necessarily limited to 25%."

So having the 412i and a profit share will limit the deductibility by a %. That is because?

And one can have a profit share with a 412, is the minimum coverage limit 40% of employees? Can you have a 401k with non matching and a 412i? Who has to be covered?

Are you saying that the cross testing refers to the people in the plan (owners vs key employees) or people in the plan vs outside the plan

Sorry for the simple questions, Thanks for the answers

Saul

[AndyH]

The deduction limit is always the same for combinations of plans that cover at least some of the same employees, that is the deduction is the greater of the DB minimum or 25%. And a 412(i) is a type of DB.

Beginning in 2002 employee deferrals do not count towards the 25%; previously they did. This means that you can have a DB plan with a contribution over 25% of payroll and still have a 401(k) with deferrals only. But you could not also have profit sharing contributions because they would not be deductible.

Regarding coverage, the rules are the same regardless of the plan, assuming it is a qualified plan (i.e. not a SEP or something similar).

You need to either pass the ratio percentage (70% not 40%) test or the average benefits test. The latter is a test that allows you to have a lower percentage head count (40% might work) provided that the benefit are skewed 70% towards non HCEs.

Advanced techniques sometimes allow plans to be combined for such tests, thus the DB/DC combo approach. However, stringent testing requirements must be satisfied. Comments in this thread refer to this being overlooked by novices.

Hope that gives you a start. Others can chip in as well. I respect the sales guy who wants to understand what he is selling.