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IRC Section 412(i) Plans and Defined Benefit Plans After the Pension Protection Act of 2006

IRC Section 412(i) Plans and Defined Benefit Plans After the Pension Protection Act of 2006. Presented By: Michael F. Kresl, CPA. WITH THE PASSAGE OF THE PENSION PROTECTION ACT.

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IRC Section 412(i) Plans and Defined Benefit Plans After the Pension Protection Act of 2006

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  1. IRC Section 412(i) Plans and Defined Benefit Plans After the Pension Protection Act of 2006 Presented By: Michael F. Kresl, CPA

  2. WITH THE PASSAGE OF THE PENSION 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)

  3. TOPICS 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

  4. 412(i) FULLY INSUREDDEFINED BENEFIT PLANS • THE LARGEST POSSIBLE DEDUCTION FOR THE BUSINESS OWNER WITH LITTLE TIME LEFT FOR RETIREMENT

  5. HISTORY…. NOT A GREY AREA . . .BEFORE ERISA

  6. WHAT’S THE BIG DEAL WITH 412(i) “FULLY INSURED PENSION PLANS?” BIG DEDUCTIONS

  7. WHAT IS A DEFINED BENEFIT PLAN? • A PROMISE OF FUTURE BENEFITS • LITTLE FLEXIBILITY IN FUNDING

  8. WHAT IS THE MAXIMUM 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)

  9. WHAT IS THE MAXIMUM DEDUCTION ALLOWED TOA DB PLAN? • WHATEVER IS NECESSARY TO FUND THE BENEFITS IN THE PLAN • THEREFORE, NO MAXIMUM CONTRIBUTION AND NO MAXIMUM DEDUCTION!

  10. HOW DOES A 412(i) PLAN DIFFER FROM A TRADITIONAL DB PLAN? • PLAN FUNDING • METHOD OF CALCULATING THE ACCRUED BENEFIT

  11. REQUIREMENTS TO COMPLY WITH SECTION 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

  12. PLAN FUNDING • PLAN INVESTMENTS MUST BE: • IN GUARANTEED INSURANCE COMPANY CONTRACTS • GENERAL RULE. . . AND IF TRUE TO IRS INTENTIONS . . . • 100% FIXED ANNUITY, OR • COMBINATION OF FIXED ANNUITY AND WHOLE LIFE INSURANCE BENEFITS MUST BE GUARANTEED

  13. FUNDING FOR A TRADITIONAL 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%)

  14. CALCULATIONS 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

  15. CALCULATIONS (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

  16. SUMMARY • 412(i) vs. TRADITIONAL PLAN • 74% MORE CASH @ 65 • $970,000 VERSUS $560,000 • 105% HIGHER 1st YEAR DEDUCTION • $82,149 VERSUS $40,081

  17. ACCRUED 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)

  18. INSURANCE IN A DEFINED BENEFIT PLAN NO INSURANCE IN THE PLAN: INSURANCE ANNUITY TOTAL PREMIUM DEPOSITPLAN COST -0- $99,394 $99,394 $2,594,436 FACE AMOUNT IN THE PLAN: INSURANCE ANNUITY TOTAL PREMIUMDEPOSITPLAN COST $66,261 $44,743 $111,004

  19. MAXIMUM LIFE INSURANCE SAFE HARBORS 1) FACE AMOUNT OF 100 TIMES THE PROJECTED MONTHLY BENEFIT OR 2) PREMIUM CALCULATED UNDER REV. RUL. 74-307

  20. ADDITIONAL INSURANCE 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

  21. IF 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

  22. COMPARISON OF MAXIMUM CONTRIBUTIONS(ASSUMING NRA OF 65) TRADITIONAL 412(i) 412(i) AGEDEFINED BENEFITANNUITY ONLYMAX 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

  23. AT 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

  24. ADVANTAGES OF 412(i) OVER TRADITIONAL DB PLANS • BETTER UNDERSTANDING OF ACCRUED BENEFIT • NO REVERSION OF EXCESS ASSETS UPON TERMINATION • CONTRIBUTIONS CONSISTENT

  25. NO ENROLLED ACTUARY SO SMALLER ADMINISTRATIVE FEES • NO IRS ATTACK ON PLAN ASSUMPTIONS • BENEFITS GUARANTEED BY AN INSURANCE COMPANY • LARGER INITIAL DEDUCTIONS !!

  26. CONCERNS WITH 412(I) FULLY INSURED PENSION PLANS • OVERALL SUITABILITY ISSUES • IRS SCRUTINY AND “ABUSIVE” PLANS • GATT IMPACT ON DISTRIBUTIONS

  27. 412(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

  28. IRS SCRUTINY AND “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

  29. HOW TO SPOT POTENTIALLY ABUSIVE 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”

  30. GENERAL AGREEMENT ON 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.”

  31. “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 __________________________________________________________ “GATT-FREE” LUMP SUM: $2,062,966 AMOUNT “LOST”: $1,352,863

  32. 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.”

  33. 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

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

  35. Questions??? For additional information contact: Michael F. Kresl, CPA 866-892-1311 or mike@mikekresl.com

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