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 INSURED DEFINED 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 TO A 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? 1.PLAN FUNDING 2.METHOD OF CALCULATING THE ACCRUED BENEFIT

11 REQUIREMENTS TO COMPLY WITH SECTION 412(i) OF THE IRS CODE 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 % FIXED ANNUITY, OR 2.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 CALCULATIONS TRADITIONAL DEFINED BENEFIT PLAN MONTHLY BENEFIT ANNUITY FACTOR CASH 65 $5,000 x $112 = $560,000 AMOUNT REQUIRED TO CONTRIBUTE ANNUALLY OVER 10 YEARS IF 6% INTEREST EARNED = $40,081

15 CALCULATIONS (CONTINUED) CALCULATIONS (CONTINUED) 412(i) PLAN MONTHLY BENEFIT ANNUITY FACTOR CASH 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 65 $970,000 VERSUS $560, % 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 DEPOSIT PLAN COST -0- $99,394 $99,394 $2,594,436 FACE AMOUNT IN THE PLAN: INSURANCE ANNUITY TOTAL PREMIUM DEPOSIT PLAN 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

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, (i) DEFINED BENEFIT $ 332,081

22 COMPARISON OF MAXIMUM CONTRIBUTIONS (ASSUMING NRA OF 65) COMPARISON OF MAXIMUM CONTRIBUTIONS (ASSUMING NRA OF 65) TRADITIONAL 412(i) 412(i) AGE DEFINED BENEFIT ANNUITY ONLY MAX LIFE & ANNUITY 40 $ 32,696 $ 75,404 $ 93, $ 48,764 $ 102,312 $ 127, $ 77,068 $ 147,814 $ 186, $ 136,094 $ 239,812 $ 307, $ 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 ___________________________________________________________ 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 or