412(i) and 401(k)?

[betheeg]

We have a client that wants to put as much $ away as possible in the next 5-10 years. He is a sole prop. His only employee is his wife. They are both in their 50's. If he establishes a 412(i), can he also set up a 401(k)? (I believe he can, but want to be sure.) More importantly, if he sets up the 412(i) and maximizes his and his wife's contribution, what will they be able to contribute to the 401(k) (deferrals, employer contribution)? What do you guys think about this? Opinions? Other options?

If more info is necessary to answer my questions, let me know.

Thanks in advance for the help.

[Guest Carol the Writer]

He can set up a 412(i) and a deferral-only 401(k) since, in light of EGTRRA, salary deferrals are not considered part of the employer deductible contribution. If he puts er contribs, safe harbor or whatever, into the 401(k), he'll be subject to the 404(a)(7) 25% of comp limit on deductions to the two plans. His wife can be in both plans and have 401(k) maximal deferrals, also, provided she meets the 415 limit of 100% of comp.

Carol Caruthers

[Guest mjb]

Carol: why are his contributions subject to the 25% deduction limit? IRC 404(n) provides that salary deferrals to a 401k plan are exempt from the limits under 404(a)(7) until 2011.

[saabraa]

I'm not Carol, but we're saying the 404(a)(7) limits apply to the profit sharing contributions other than the elective deferrals.

[betheeg]

So there can be no employer contributions put into the 401(k), not even for his wife?

Thanks for the input so far.....

[AndyH]

First, I should answer your question: That is right. The deduction is limited to to greater of the minimum DB or 25% of pay, which is less than the minimum db plus something. Deferrals do not count.

Betheeg, why is 412(i) the first idea that comes to your mind? I'm curious as to why that would be, in the days of listed transactions and "Howdy letters".

Why a 401(k) instead of an annuity or a jumbo variable annuity insurance policy? Buzzwords?

[betheeg]

AndyH- The 412(i) was the client's idea. From my understanding (which is extremely limited with DB plans)412(i) is funded with insurance contracts and annuitys. The client also wanted a way to be able to have some money invested in the market, hence the 401(k).

To be honest, this is not my area at all. I was just trying to get the original question answered for one of the partner's at my firm. If you think there is a better way to do this instead of the 412(i) that can accomplish the client's goal, please let me know. I am open to suggestions!

Thanks so much for the help!

[AndyH]

A DB and a 401(k) does seem like a combination worthy of consideration. A 412(i) is a variation of a DB. There are arguments for and against. Mine are usually against.

But your question was kind of like suggesting that someone consider as a part of plan design a "profit sharing plan fully invested in collectibles". The plan design is the "profit sharing plan". The investment design is the second matter where 412(i) may or may not enter the discussion. Combining both discussions into one sentence initially is a tell tale sign of a sales proposal, not a thoughtful plan design.

Back to your specific situation, your client needs education in both retirement plan options and investment matters, separately IMHO. He may well need insurance; that may or may not be appropriate within a retirement plan. Combining the two issues, retirement savings and insurance needs, is not a good idea IMHO until both are explored separately in some detail to clarify the true objectives and needs.

As FL says, hope this is helpful.

[betheeg]

Very helpful Andy, much appreciated.

One other thing. Why are your arguments against 412(i)? Again, not my area, but I have read and heard that you are able to put more money away with a 412(i) vs. a DB.

[AndyH]

That used to be true due to some questionable design features that are now high on the IRS' radar screeen, plus the usual addition of life insurance that can be added to a regular DB as well. Beyond that, the larger deduction goes into sustandard investment return and expenses IMHO.

There are dozens of such discussions on this board that discuss these items in depth if you are inteested. I would suggest doing a search.

[Lame Duck]

Most insurance companies credit the annuity contract with gains of 3.0% to 3.5% per year. Most actuaries will use a rate of return of 5.0% to 6.0%. The use of a lower rate of return will require a higher contribution.

This is perfectly acceptable if the client intends to take a distribution in the form of an annuity contract. However, if the client is taking a lump sum distribution, which about 99% of my DB clients do, the amount paid out under the plan will be the same in either case. It will require the use of a higher interest rate to calculate the distribution (assuming a maximum benefit under the plan) and may result in excess assets in the 412(i) plan.

There have been a number of very lengthy discussions about the 412(i) versus DB here on Benefits Link. If you want some more information about the controversy, I suggest you look at some of those.

[AndyH]

This is perfectly acceptable if the client intends to take a distribution in the form of an annuity contract. However, if the client is taking a lump sum distribution, which about 99% of my DB clients do, the amount paid out under the plan will be the same in either case. It will require the use of a higher interest rate to calculate the distribution (assuming a maximum benefit under the plan) and may result in excess assets in the 412(i) plan.

Acceptable, perhaps. A good idea? Perhaps not. With some planning, a regular DB plan could provide a purchased annuity at the end also, after having earned more than 3% to 3.50% per year. In that way, the same benefit is paid at a much lower cost.

[david rigby]

I second everything Andy said. BTW, here is one of the more "passionate" discussion threads:

http://benefitslink.com/boards/index.php?showtopic=31437