What producers must know about 412(e)(3) plans
By Nick Paleveda MBA J.D. LL.M
National Pension Partners
If you are an enrolled actuary or life insurance producer, you will be surprised how much you already know about 412(e)(3).
A producer meets with a client to demonstrate the advantages of a whole life policy. The client is interested, but cash flow is tight, taxes are high and expenses are troublesome. Next, the producer says, "How about buying the policy on a tax deductible basis?"
The client's ears perk up. "How do you buy the life insurance with a tax deduction?" The producers answers, "You cannot buy life insurance and deduct it; however, you can create a 412(e)(3) plan and then deduct the insurance cost."
A 412(e)(3) plan is a pension plan funded with insurance and annuity contracts. Life insurance is limited to 50 percent of the plan contributions or 100 times the monthly income of the participant at retirement. The balance of the contribution — 50 percent — will be placed into an annuity. The plan is sponsored by an entity which can be a corporation, LLC or even a sole proprietorship. The plan contributions are deductible from federal income tax, state income tax, Medicare tax and Obamacare tax. These assets are also exempt from lawsuits and creditor claims.
Who needs a 412(e)(3) plan?
The higher-income tax bracket taxpayer will be more interested in the benefits of the plan. A recent case I was told about concerned a physician making about $500,000 a year. Due to tax law changes, his tax bill was to increase from $129,000 to $150,000 in 2013. His financial advisor set up a 412(e)(3) plan, and the tax bill was reduced to $29,000.
How do I set up a plan?
Working with a good third-party administration company (TPA) that specializes in this area is essential. There are many traps in ERISA awaiting the taxpayer, the plan sponsor and the agent which can be costly if the plan is not set up correctly.
The retirement planning team
Retirement planning using qualified plans is a team sport. The producer must interact with the TPA, the CPA and the client. Producers who are lone wolves may not fit well in the retirement planning marketplace. What about other plans, like Section 79 and 401(k) plans?
First, under Section 79, the life insurance is not fully deductible. Second, a 401(k) plan is not fully deductible, as Social Security and Medicare taxes are taken out first before the deferral is made. This can amount to an additional 15.3 percent tax burden.
How long have these plan been around?
412(e)(3) is the new section under the Pension Protection Act of 2006. Before that was the 1974 Section 412(i), and before that was the 1921 MetLife group annuity.
I heard 412(i) plans were bad
Certain 412(i) plans with springing cash value policies were deemed listed transactions. However, certain 401(k) plans with accelerator features are also listed transactions. The IRS attacks abusive plans.
Are the returns poor in a 412(e)(3)?
Since 2000, if you invested in an annuity-only 412(e)(3) plan you would have actually outperformed the S&P 500 — which, according to some sources, 90 percent of the money managers did not do — and you took little or no risk in your retirement plan.
What about the legal documents, the trust, the form 5500, the plan contribution amounts — who does that?
That is why you work with a good TPA.
What is the most common question the CPA has about 412(e)(3) plans?
"What is a 412(e)(3) plan?" Many CPAs are not trained in pensions and hence know very little about this plan. If you are an enrolled actuary or life insurance producer, you will be surprised how much you already know about 412(e)(3).