What Was a 412(i) Plan?
Let me tell you directly: a 412(i) plan was a defined-benefit pension plan created for small business owners in the U.S. It qualified as a tax-qualified pension, so your company could deduct contributions right away, and employees could deduct theirs too. The only funding options were guaranteed annuities or a mix of annuities and life insurance. This setup ended after December 31, 2007, when it got replaced by the 412(e)(3) plan.
Key Takeaways
Here's what you need to know upfront. The 412(i) was built as a defined-benefit pension for small U.S. business owners. As a tax-qualified plan, it let companies deduct contributions immediately. Funding came solely from guaranteed annuities or annuities plus life insurance. The IRS stepped in because of tax avoidance issues and swapped it out for the 412(e)(3).
Understanding a 412(i) Plan
You should note that 412(i) plans were made for small business owners who struggled to balance investing in their company and saving for employee retirements. What set it apart was the fully guaranteed retirement benefits it offered.
Insurance companies provided and backed these plans, and you could only hold insurance products like annuities and life insurance in them. Those contributions meant big tax deductions for you.
An annuity, if you're not familiar, is something you buy with a lump sum or payments, and the insurance company gives you fixed payments later on—mostly for retirement income.
Because of the hefty annual premiums required, a 412(i) plan wasn't right for every small business owner. It worked better for established, profitable ones.
For instance, a stable, mature business with profits would handle a 412(i) plan better than a startup scraping by or one fresh off angel funding.
Those early-stage companies usually lack the free cash flow to save consistently for retirements; instead, you reinvest profits or funding back into the business for growth and updates.
412(i) Plans and Compliance Issues
In February 2004, the IRS spotted abuses and tax avoidance in plans like the 412(i), especially with life insurance policies in retirement setups. They issued guidance to stop these schemes, focusing on policies tailored for high-income employees.
412(e)(3)
Because of those tax avoidance problems with the 412(i), the IRS shifted its provisions to 412(e)(3) for plans starting after December 31, 2007. It works much like the old one but skips the minimum funding rule.
IRS Requirements for 412(e)(3)
- Plans must be funded exclusively by the purchase of a combination of annuities and life insurance contracts or individual annuities.
- Plan contracts must provide for level annual premium payments to be paid extending not later than the retirement age for each individual participating in the plan, and commencing with the date the individual became a participant in the plan (or, in the case of an increase in benefits, commencing at the time such increase becomes effective).
- Benefits provided by the plan are equal to the benefits provided under each contract at normal retirement age under the plan and are guaranteed by an insurance carrier (licensed under the laws of a state to do business with the plan) to the extent premiums have been paid.
- Premiums payable under such contracts for the plan year, and all prior plan years, have been paid before lapse or there is a reinstatement of the policy.
- No rights under such contracts have been subject to a security interest at any time during the plan year.
- No policy loans are outstanding at any time during the plan year.
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