The IRS was taking a good hard look at this top heavy funded Plan. If you are in the 45-60 age range and have some make-up retirement savings money, are self employed or own a business...and you need to save-this plan incorporates Life Insurance and annuities for a guaranteed benefit-but allows large favorable make-up fundings for the business owner.

Date:   5/27/2005 1:31:40 AM ( 19 y ago)

412(i)s Back in the Game

IRS guidance clears up confusion on fair market value


BY ELIZABETH FESTA


Interested in 412(i)s as a reliable, stable plan for your clients? Officials in the 412(i) industry say it’s safe to go back into the water now that the IRS has issued new guidance on calculating the fair market value of 412(i) plans.


Regulatory scrutiny of these defined benefit plans, which are funded with guaranteed life or annuity insurance contracts, has been subsiding because new IRS guidance is in place to fix some trouble spots in the plans. The popularity of 412(i) plans is also rising again because they offer a guaranteed rate of return, and the increase in the amount one can fund as a benefit. Another boost to the plans are advantages to defined benefit plans offered by The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001.


One reason 412(i)s are increasingly popular because “if the market goes sideways or south, people in a 412(i) plan continue to make money every year,” notes Nick Palaveda, CEO of The 412(i) Company in Bellingham, Washington. The plans have outperformed the marketplace in the past few years because of their guaranteed rate of return of about 3%, although gains can grow to 8% if the plans are structured properly, according to Palaveda.


Mark Cantor, senior counsel on tax issues for the American Council of Life Insurers (ACLI), says there is renewed interest in the product because of the safe harbors and the fair market value definition in recently issued IRS guidance. The ACLI lobbied for a safe harbor that gave value to the life insurance policy funding the 412(i) plan. The formula was modified to accommodate traditional insurance contracts. In the original guidance, the formula used a universal policy to determine fair market value.


There was a “pullback” in 412(i)s as the IRS cracked down on abusive practices known as “springing cash values,” says Michael Kitces, president of Pinnacle Advisory Group in Columbia, Maryland. Investors “were going nowhere near” the plans, he says, but “now there is a resurgence as the dust settles.”


The plans are exempt from minimum funding requirements under Section 412 of the Internal Revenue Code, and attract people who can make huge contributions. However, abusive practices such as “springing cash values” spurred the IRS to clamp down on what the agency saw as exploitation of these products in the past few years. With springing cash values, the idea was that the investor would buy a life insurance policy that had a low cash surrender value and after the surrender charges evaporated, would wait a few years to access a huge amount of invested cash, tax-free. However, since the IRS views retirement plans as long-term plans, it believed the arrangement was a sham, a tax shelter, or a disguised payment to the employee, planners say. The IRS has been issuing a series of new rules and guidance, including one on May 1 that shut down exploitive practices and offered more clarity to the marketplace. The IRS now requires payment of income tax upon retrieving the funds accumulated in 412(i)s.


Still, all this recent negative attention doesn’t change the 412(i)’s underlying value—the plans reduce volatility of funding, and allow investors to put in a lot more money up front in return for a lower rate of return, according to Kitces. A 412(i) plan is good for individuals four to eight years away from retirement with substantial income who don’t mind having a lowered return for a couple of years in return for a high funding amount—then they can roll over the monies into an IRA.


Palaveda, a former estate tax attorney, started the company not because the IRS was cleaning up questionable practices but because of EGTRRA, which was going to put him out of business as an estate lawyer for the very wealthy. So he started The 412(i) Company. EGTRRA “put all the benefits back into DB plans; it raised the amount you can take out guaranteed for life. You can fund more into these plans,” he says.


Palaveda says business at The 412(i) Company has grown 250% over the past three years, and he anticipates that growth to continue because of EGTRRA. His company administers the plans for 10 of the 35 companies now offering 412(i) plans, such as Principal Financial Group and Transamerica, owned by Aegon.



 

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