A 412(i) plan is a type of defined benefit pension plan. It is designed for small business owners and self-employed individuals, and is named after the section of the Internal Revenue Code that governs these plans.
A 412(i) plan is a qualified plan, meaning it meets certain requirements set forth by the IRS and is eligible for certain tax benefits. Like other defined benefit plans, a 412(i) plan promises a specific benefit to the employee at retirement, usually based on a formula that takes into account factors such as salary and years of service.
Under a 412(i) plan, contributions are typically made by the employer and are based on a set formula, with the employer assuming the investment risk. Employers are able to deduct the contributions they make to the plan, and employees do not pay taxes on the benefits they receive until they withdraw them.
The 412(i) plans are not commonly used today because the plans require that the employer fund the plan with a guarantee insurance contract. These plans were heavily marketed in the 1990s, but the IRS issued new regulations in the early 2000s that greatly limited the use of 412(i) plans.
The 412(i) plan was replaced by the 412(e)(3) plan after Dec. 31, 2007.
What is 412(e)(3)
The 412(i) plan, a type of defined benefit pension plan, was popular in the 1990s but was found to be susceptible to abuse and tax avoidance schemes. As a result, the Internal Revenue Service (IRS) moved the 412(i) provisions to 412(e)(3) for plans beginning after December 31, 2007. The new provisions function similarly to 412(i), but it is exempt from the minimum funding rule.
According to the IRS, plans under 412(e)(3) must meet the following requirements:
- They must be funded exclusively by the purchase of a combination of annuities and life insurance contracts or individual annuities.
- Plan contracts must provide for level annual premium payments extending until the retirement age of each individual participating in the plan, starting from the date of participation (or, in the case of an increase in benefits, starting at the time such increase becomes effective).
- Benefits provided by the plan must be equal to the benefits provided under each contract at normal retirement age under the plan and must be guaranteed by an insurance carrier licensed under the laws of a state to do business with the plan, to the extent premiums have been paid.
- Premiums payable under such contracts for the plan year, and all prior plan years, must be paid before lapse or there is a reinstatement of the policy.
- No rights under such contracts can be subject to a security interest at any time during the plan year.
- No policy loans can be outstanding at any time during the plan year.
It’s important to note that 412(i) plans are not commonly used today because of the new regulations issued by the IRS in early 2000s which greatly limited the use of 412(i) plans.