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IRC Section 412(i) Plans IRC Section 412(i) Plans and Defined Benefit Plans and Defined Benefit Plans

After the Pension After the Pension Protection Act of 2006Protection Act of 2006

Presented By:

Michael F. Kresl, CPA

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WITH THE PASSAGE OF THE WITH THE PASSAGE OF THE PENSION PROTECTION ACTPENSION PROTECTION ACT

SECTION 412(I) WILL NO LONGER EXIST, “FULLY INSURED PENSION PLAN” OR “INSURANCE CONTRACT PLAN” LANGUAGE WILL REMIAN UNCHANGED FROM 412(I) BUT WILL BE FOUND UNDER:

412 (e) (3)

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TOPICS TO DISCUSSTOPICS TO DISCUSS

• DEFINED BENEFIT PLANS REVIEW

• WHAT IS A 412(I) “FULLY INSURED” PENSION PLAN

• CONCERNS WITH 412(I) PLANS

• 412(E) (3) PLANS AND THE PPA

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412(i) FULLY INSURED412(i) FULLY INSUREDDEFINED BENEFIT PLANSDEFINED BENEFIT PLANS

• THE LARGEST POSSIBLE DEDUCTION FOR THE BUSINESS OWNER WITH LITTLE TIME LEFT FOR RETIREMENT

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HISTORY….

NOT A GREY AREA . . .BEFORE ERISA

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WHAT’S THE BIG DEAL WHAT’S THE BIG DEAL WITH 412(i) “FULLY WITH 412(i) “FULLY INSURED PENSION INSURED PENSION

PLANS?”PLANS?”

BIG DEDUCTIONS

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WHAT IS A DEFINED WHAT IS A DEFINED BENEFIT PLAN?BENEFIT PLAN?

• A PROMISE OF FUTURE BENEFITS

• LITTLE FLEXIBILITY IN FUNDING

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WHAT IS THE MAXIMUM WHAT IS THE MAXIMUM BENEFIT FROM A DB PLAN?BENEFIT FROM A DB PLAN?

• GENERALLY THE PLAN CAN FUND FOR A MAXIMUM BENEFIT OF 100% OF SALARY WITH A DOLLAR LIMIT OF $175,000 (FOR THE YEAR 2006)

$14,583 MAXIMUM MONTHLY BENEFIT (WITH 10 YEAR’S PARTICIPATION)

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WHAT IS THE MAXIMUM WHAT IS THE MAXIMUM DEDUCTION ALLOWED TODEDUCTION ALLOWED TO

A DB PLAN?A DB PLAN?

• WHATEVER IS NECESSARY TO FUND THE BENEFITS IN THE PLAN

• THEREFORE, NO MAXIMUM CONTRIBUTION AND NO MAXIMUM DEDUCTION!

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HOW DOES A 412(i) PLAN HOW DOES A 412(i) PLAN DIFFER FROM A DIFFER FROM A TRADITIONAL DB PLAN?TRADITIONAL DB PLAN?

1. PLAN FUNDING

2. METHOD OF CALCULATING THE ACCRUED BENEFIT

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REQUIREMENTS TO COMPLY WITH REQUIREMENTS TO COMPLY WITH SECTION 412(i) OF THE IRS CODESECTION 412(i) OF THE IRS CODE

ALL ASSETS MUST BE HELD WITH AN INSURANCE COMPANY IN FIXED CONTRACTS THAT GUARANTEE THE BENEFITS

NO LOANS ARE ALLOWED ON THE CONTRACTS

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PLAN FUNDINGPLAN FUNDING• PLAN INVESTMENTS MUST BE:

– IN GUARANTEED INSURANCE COMPANY CONTRACTS

– GENERAL RULE. . . AND IF TRUE TO IRS INTENTIONS . . .

1. 100% FIXED ANNUITY, OR 2. COMBINATION OF FIXED ANNUITY AND WHOLE

LIFE INSURANCE

BENEFITS MUST BE GUARANTEED

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FUNDING FOR A TRADITIONAL FUNDING FOR A TRADITIONAL DB PLAN VS. 412(I)DB PLAN VS. 412(I)

• TRADITIONAL PLANS USE IRS PARAMETERS THAT MAY BE, FOR EXAMPLE, AN ANNUITY PURCHASE RATE OF $112 PER DOLLAR OF MONTHLY BENEFIT AND A 6% PRE-RETIREMENT INTEREST RATE

• 412(I) FUNDING MUST BE BASED UPON INSURANCE COMPANY CONTRACT GUARANTESS AND COULD BE DOUBLE THE ANNUITY PURCHASE RATE ($194) AND ONE HALF THE PRE-RETIREMENT INTEREST RATE (3%)

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CALCULATIONSCALCULATIONS

TRADITIONAL DEFINED BENEFIT PLAN

•MONTHLY BENEFIT ANNUITY FACTOR CASH REQUIRED @ 65 $5,000 x $112 = $560,000

• AMOUNT REQUIRED TO CONTRIBUTE ANNUALLY OVER 10 YEARS IF 6% INTEREST EARNED = $40,081

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CALCULATIONS CALCULATIONS (CONTINUED)(CONTINUED)

412(i) PLAN

MONTHLY BENEFIT ANNUITY FACTOR CASH REQUIRED @ 65

• $5,000 x $194 = $970,000

• AMOUNT REQUIRED TO CONTRIBUTE ANNUALLY OVER 10 YEARS IF 3% INTEREST EARNED = $82,149

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SUMMARYSUMMARY

• 412(i) vs. TRADITIONAL PLAN

• 74% MORE CASH @ 65

• $970,000 VERSUS $560,000

• 105% HIGHER 1st YEAR DEDUCTION

• $82,149 VERSUS $40,081

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ACCRUED BENEFITACCRUED BENEFIT

• THE ACCRUED BENEFIT IS SIMPLY THE CASH VALUE OF THE INSURANCE AND ANNUITY CONTRACTS ISSUED TO EACH PARTICIPANT

(ESSENTIALLY AN INDIVIDUAL ACCOUNT BALANCE PLAN)

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INSURANCE IN A INSURANCE IN A DEFINED BENEFIT PLANDEFINED BENEFIT PLAN

NO INSURANCE IN THE PLAN: INSURANCE ANNUITY TOTAL

PREMIUM DEPOSIT PLAN COST

-0- $99,394 $99,394

$2,594,436 FACE AMOUNT IN THE PLAN: INSURANCE ANNUITY TOTAL

PREMIUM DEPOSIT PLAN COST

$66,261 $44,743 $111,004

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MAXIMUM LIFE INSURANCE MAXIMUM LIFE INSURANCE SAFE HARBORSSAFE HARBORS

1) FACE AMOUNT OF 100 TIMES THE

PROJECTED MONTHLY BENEFIT OR

2) PREMIUM CALCULATED UNDER

REV. RUL. 74-307

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ADDITIONAL INSURANCE ADDITIONAL INSURANCE NOTE:NOTE:

• LIFE INSURANCE DIVIDENDS MUST BE USED TO REDUCE THE NEXT YEAR’S PLAN CONTRIBUTION

• INTEREST PAID ON THE ANNUITY IN EXCESS OF THE GUARANTEED RATE MUST BE USED TO REDUCE THE NEXT YEAR’S CONTRIBUTION

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IF GOAL IS MAX DEDUCTIONIF GOAL IS MAX DEDUCTION OWNER AGE 52 (Ret age 62)

SALARY $175,000

DEDUCTION LIMITS:

• PROFIT SHARING $ 45,000• MONEY PURCHASE $ 45,000• TARGET PLAN $ 45,000• DEFINED BENEFIT $ 145,374• 412(i) DEFINED BENEFIT $ 332,081

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COMPARISON OF COMPARISON OF MAXIMUM CONTRIBUTIONSMAXIMUM CONTRIBUTIONS

(ASSUMING NRA OF 65)(ASSUMING NRA OF 65)

TRADITIONAL 412(i) 412(i)

AGE DEFINED BENEFIT ANNUITY ONLY MAX LIFE & ANNUITY

40 $ 32,696 $ 75,404 $ 93,379 45 $ 48,764 $ 102,312 $ 127,367 50 $ 77,068 $ 147,814 $ 186,438 55 $ 136,094 $ 239,812 $ 307,938 60 $ 159,109 $ 258,910 $ 357,156

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AT RETIREMENTAT RETIREMENT

• CASH OPTION IS CHOSEN

• ASSETS ARE ROLLED TO IRA

• IF ANNUITY DESIRED, THE MARKET CAN BE SHOPPED FOR THE BEST POSSIBLE RATE TO ANNUITIZE

• INTERGENERATIONAL IRA POSSIBILITIES

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ADVANTAGES OF 412(i) OVER ADVANTAGES OF 412(i) OVER TRADITIONAL DB PLANSTRADITIONAL DB PLANS

• BETTER UNDERSTANDING OF ACCRUED BENEFIT

• NO REVERSION OF EXCESS ASSETS UPON TERMINATION

• CONTRIBUTIONS CONSISTENT

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• NO ENROLLED ACTUARY SO SMALLER ADMINISTRATIVE FEES

• NO IRS ATTACK ON PLAN ASSUMPTIONS

• BENEFITS GUARANTEED BY AN INSURANCE COMPANY

• LARGER INITIAL DEDUCTIONS !!

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CONCERNS WITH 412(I) FULLY CONCERNS WITH 412(I) FULLY INSURED PENSION PLANSINSURED PENSION PLANS

• OVERALL SUITABILITY ISSUES

• IRS SCRUTINY AND “ABUSIVE” PLANS

• GATT IMPACT ON DISTRIBUTIONS

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412(I) AND CLIENT SUITABILITY412(I) AND CLIENT SUITABILITY• PREDICTABLE PROFITABILITY WITH LITTLE

YEAR TO YEAR FLUCTUATION

• SIGNIFICANT NEED FOR HIGH CURRENT AND FUTURE TAX DEDUCTIONS

• ABILITY TO DO 6 FIGURE CONTRIBUTIONS

• 5 YEAR (OR MORE) RETIREMENT HORIZON

• FEW OR NO EMPLOYEES NOW OR FUTURE

• NOT ADVERSE TO “FIXED” INVESTMENTS

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IRS SCRUTINY AND IRS SCRUTINY AND “ABUSIVE” PLANS“ABUSIVE” PLANS

• “SPRINGING CASH VALUE” OR “SPECIAL” LIFE INSURANCE POLICIES

• LIFE INSURANCE ONLY PLANS

• “EXCESSIVE LIFE INSURANCE IN PLANS

• “CARVE OUT” OR “CUSTOM” PLANS

• HYBRID INVESTMENTS IN PLANS

• PLANS FROZEN OR TERMINATED WITHIN 3 YEARS

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HOW TO SPOT POTENTIALLY HOW TO SPOT POTENTIALLY ABUSIVE PLANSABUSIVE PLANS

• PLANS “SOLD” AS A TEMPOARY FIX – DEDUCTION TO OFFSET LARGE ONE OR TWO YEAR WINDFALL

• PLANS SOLD PRIMARILY AS A LIFE INSURANCE VEHICLE

• PLANS THAT DESCRIMINATE IN FUNDING CONTRACTS

• PLANS THAT “SOUND TO GOOD TO BE TRUE”

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GENERAL AGREEMENT ON GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT)TARIFFS AND TRADE (GATT)

• THE “GATT LIMIT” IMPOSES A MAXIMUM AMOUNT THAT CAN BE TAKEN AS A LUMP SUM (NOT ANNUITY) FROM DB PLANS INCLUDING 412(I) PLANS.

• THE “GATT LIMIT” IS NOT A STATIC AMOUNT BUT CAN FLUCTUATE BASED UPON A CALCULATION THAT USES THE 30 TREASURY MONTHLY YIELD.

• A PARTICIPANT MAY LOSE THE AMOUNT IN EXCESS OF THE “GATT LIMIT.”

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““GATT LIMIT EXAMPLE”GATT LIMIT EXAMPLE” CLIENT: AGE 50

SALARY: $250,000

RETIREMENT: AGE: 65

FIRST YR CONTRIBUTION: $221,000

___________________________________________________________

CASH @ RETIREMENT: $3,416,829

ANNUAL ANNUITY FOR LIFE: $ 175,000

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“GATT-FREE” LUMP SUM: $2,062,966

AMOUNT “LOST”: $1,352,863

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GATT LIMIT “REAL WORLD”GATT LIMIT “REAL WORLD”

• TO ADDRESS THE LIMITATIONS IMPOSED BY GATT, THE TPA WILL TYPICALLY AMEND, FREEZE OR TEMINATE THE PLAN BEFORE IT APPROACHES THE “GATT LIMIT.”

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PROSPECTIVE CLIENTS FOR 412(i)PROSPECTIVE CLIENTS FOR 412(i)

• AN OLDER OWNER OF A SMALL BUSINESS (USUALLY AGE 50+)

• PREDICTABLE “EXCESS” PROFITS

• WANTS LARGE DEDUCTIONS

• HAS FEW EMPLOYEES

• WILLING TO SETTLE FOR “FIXED ASSETS” FOR THE PLAN

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THE FUTURE OF 412(I) OR 412(E) (3) THE FUTURE OF 412(I) OR 412(E) (3) PLANS UNDER THE PENSION PLANS UNDER THE PENSION

PROTECTION ACT OF 2006PROTECTION ACT OF 2006

THESE PLANS REMAIN VIABLE SOLUTIONS FOR SUITABLE CLIENTS PROVIDED THE PLANS ARE NOT “ABUSIVE.”

HOWEVER, THE SERVICE IS TELLING US THAT NOW MORE THAN EVER, 412(I) PLANS SHOULD FOLLOW THE LETTER AS WELL AS THE INTENT OF THE CODE AND RELATED PENSION RULES. FAILURE TO DO SO RAISES A SUBSTANCIAL RISK OF ELEMENTS OF A PLAN BECOMING “LISTED TRANSACTIONS” THAT CAN RESULT IN DEDUCTIONS BEING DISALLOWED, WITH TAXES, INTEREST, AND PENALTIES COMING INTO PLAY.

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Questions???Questions???

For additional information contact:

Michael F. Kresl, CPA

866-892-1311 or mike@mikekresl.com