412i Plan

[Gary]

A plan sponsor implements a 412i plan for himself (the owner and only participant).

The plan formula is a 100% of avg comp annuity at NRA.

He is to pay 50% life premium and 50% annuity premium as level premiums until NRA.

Say the policies guaranteed values result in a life annuity at NRA of 50k per year based on the life insurance annuity conversion rates.

Of course the owner will actually take a lump sum at NRA.

So while the policies can support a life annuity of 50k from the insurance rates, it would actually be worth a life annuity based on lump sum conversion rates of say 60k (the 415 limit).

Now the owner only received compensation of 40k in this the plan's first year.

So in effect the policy provides a projected pension (50k) that is greater than what the plan provides (40k) based on the comp of 40k.

Now in subsequent years the owner takes higher compensation and after three plan years he has an average comp of 75k.

So now his projected plan formula benefit is 75k, the insurance policy guarantee rates benefit is 50k and the 415 lump sum based on guaranteed values is 60k.

Instead of increasing premiums to address the increase in projected benefit the owner maintains the same premiuim level.

The thought being that if he terminates the plan at say NRA and the insurance values are not high enough to cover the 75k annuity he simply pays out benefits to the extent funded (ignore 436 for this discussion).

And if the values increase greater than the minimum guarantee, he has some space to avoid a surplus or at least the srplus would not be as substantial.

Now what would one suggest in terms of remedying th is situation? That is, to safeguard against an inevitable IRS audit.

Thank you.

[Mike Preston]

You are kidding, right?

[AndyH]

Here's what I'd suggest giving him:

[david rigby]

Let me guess: the insurance broker is a "friend" of the owner?

[Belgarath]

Can't you go in under VCP and "unwind" the purported 412(e)(3) plan - which clearly doesn't qualify as a 412(e)(3) - and treat it as a regular DB from inception with normal funding/actuarial requirements? While this will probably result in a reduction of some of the early deductions, it seems like a better result than getting stuck on audit, where the client will likely get flayed. Client is fortunate this hasn't yet been audited.

[Jim Norman]

I agree with Belgarath, it does not qualify as a fully insured plan since the benefits are not fully guaranteed by insurance contracts, at least after the first year.

[Gary]

I was able to get some actual data and will present this again.

The plan provides for a 100% of comp benefit at NRA.

Participant has 60k comp for first year.

The annuity based on the guaranteed cash values at ret. and the insurance company annuity conversion rates produces pension of 47k.

However, using the same guaranteed cash value at ret produces a 415 annuity of 85k if the participant takes a lump sum, which he will.

So right off the bat the issue of differing conversion rates between lump sum and insurance annuity causes dilemma.

Using insurance conversion rates may make sense with a plan with many employees who are required to take an insurance annuity at ret., but doesn't seem appropriate for a one participant plan who will take a lump sum.

Based on the above, we have a situation where the premium paid is not large enough based on guaranteed rates, while at the same time would produce a surplus at retirement when participant takes lump sum.

A way of designing the plan based on the above information may have been to provide that the plan provides a NR benefit of 47k (i.e. equal to insurance produced annuity) where AB is pro rated on participation (or equal to benefit produced by insurance values if greater). However, the participant would receive comp of say 100k per year and then at retirement when he takes lump sum the hope is that the plan can be amended to provide the higher annuity on lump sum basis that doesn't exceed 415 limit.

However, based on the actual facts stated above perhaps the plan can be amended to provide the proposed technique stated in the preceding paragraph.

Other views?

Thanks.