Defined Benefit
by Arun Misra
The defined benefit pension plan is the classic solution prescribed for
older business owners and professionals with tax problems. It allows larger
initial plan deposits (and tax deductions), and still accumulates interest
on those funds tax free until retirement.
Yet, thanks to a large population of aging baby boomers who need to save big
bucks in a short time and repeal of the 1.0 calculation under 412(e)(3),
those in the know would tell you that the defined benefit plan is making a
comeback. The 412 plan, because of its simple administration and high
initial tax deductions, is leading the plans.
412 Who ?
In real language, it's a "fully insured" plan; that is, one that's
funded exclusively by insurance or annuity contracts. Insurance has been
considered by some a less-than-effective funding vehicle, so what makes this
version of the defined benefit plan more attractive?
First, 412 plans play it safe: they involve no investment risk and they
guarantee all benefits.
Second, because all values are guaranteed by contract, Section 412 of the
irc (Internal Revenue Code) hence the plan's name exempts such plans from
the funding (and filing) requirements that complicate uninsured and
split-funded defined benefit plans.
Finally and here's the real plus-the fully insured plan's conservative
funding and investment assumptions tend to generate larger initial
contributions and deductions than regular defined benefit plans.
For example, the first-year contribution (to fund the maximum allowable
benefit) for a 60-year-old in a 412 plan can be 17% larger than that
provided under a standard defined benefit plan. And the advantage is greater
for participants with more years to accumulate deposits. The 50-year old
gets a 26% advantage!
Annual deposits start high and decrease each year. A perfect plan for the
owner who wishes to "wind down" the business as he or she approaches
retirement.
Who Needs A 412 Plan ?
A 412 plan is not for everyone. But the same people who would (tax laws
notwithstanding) gain the most from a standard defined benefit plan would
also find a 412 plan attractive.
Specifically, someone who:
is a small-business owner with one to five employees;
is over age 50;
has a profitable business with a stable earnings history;
wants to maximize contributions and deductions while avoiding IRS
entanglements.
Complete Services At No Separate Cost
As with all qualified plans, there is the need for competent plan
design, careful installation (to avoid those IRS audits), and annual reviews
(to keep the plan provisions and coverages in compliance). Some companies
combine these services with knowledgeable people at our local agencies and
at no separate cost to the client!
So, despite what you may have heard to the contrary, defined benefit plans
are alive and well. It's just a mater of knowing where to look!