What Is a 412(i) Plan?
A 412(i) plan is a defined-benefit pension plan that is designed for small business owners in the U.S. This is a tax-qualified benefit plan, so any amount that the owner contributes to the plan becomes available immediately as a tax deduction to the company. Guaranteed annuities or a combination of annuities and life insurance are the only things that can fund the plan.
An annuity is a financial product that an individual can purchase via a lump-sum payment or installments. The insurance company, in turn, pays the owner a fixed stream of payments at some point in the future. Annuities are primarily used as an income stream for retirees.
- A 412(i) plan is a defined-benefit pension plan that is designed for small business owners in the U.S.
- A 412(i) is a tax-qualified benefit plan, meaning the owner's contributions to the plan become a tax deduction for the company.
- Guaranteed annuities or a combination of annuities and life insurance are the only things that can fund the plan.
How a 412(i) Plan Works
Notably, 412(i) plans were developed for small business owners who often find it difficult to invest in their company while trying to save for employees' retirement. The 412(i) plan is unique in that it provides fully guaranteed retirement benefits. An insurance company must fund it, and it provides the largest tax deduction possible.
Due to the large premiums that must be paid into the plan each year, a 412(i) plan may not be ideal for all small business owners. This plan tends to benefit small businesses that are more established and profitable.
For example, a startup that had just raised several rounds of funding would be in a better position to create a 412(i) plan than one that is bootstrapped and/or has an angel or seed funding. These companies also often don’t generate enough free cash flow or FCF to put away consistently for employees’ retirement. Instead, the founding team members often re-invest any profits or outside funding back into their product or service to generate new sales and make updates to their core offerings.
412(i) Plan and Compliance Issues
In August 2017, the Internal Revenue Service (IRS) identified 412(i) plans as being involved in various types of non-compliance. These also included abusive tax avoidance transaction issues. To help organizations with 412(i) plans come into compliance, the IRS developed the following survey. They asked:
- Do you have a 412(i) plan?
- If so, how do you fund this plan? (i.e., annuities, insurance contracts, or a combination?)
- What is the amount of the death benefit relative to the amount of retirement benefit for each plan participant?
- Have you had a listed transaction under Revenue Ruling 2004-20? If so, have you filed Form 8886, Reportable Transaction Disclosure Statement?
- Finally, who sold the annuities and/or insurance contracts to the sponsor?
A survey of 329 plans yielded the following:
- 185 plans referred for examination
- 139 plans deemed to be "compliance sufficient"
- Three plans under "current examination"
- One plan noted as "compliance verified" (meaning no further contact was necessary)
- One plan labeled as not a 412(i) plan