A major goal of the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was to encourage the establishment of small-business retirement plans. Since then, as an incentive to small-business owners, the tax-deductible dollar limit and compensation percentage for such plans has increased. In 2008, the maximum contribution limit for defined-contribution plans under IRC Sec. 415(c)(I)(A) is $46,000. Participants at age 50 or more are allowed an additional catch-up limit of $5,000. While Sec. 401(k) plans are common, they limit a business’ tax-deductible contributions. Because of recent tax-law changes (provided by EGTRRA and the Pension Protection Act of 2006), which amend the Employee Retirement Income Security Act by establishing new minimum pension funding standards, many companies are eligible for a 401(k) plan, as well as defined-benefit and profit-sharing plans. Your awareness of these changes will enable you to provide new options to your clients. A defined-benefit plan is a qualified plan where a pre-determined formula sets the amount of retirement income received by a participant. With a traditional defined-benefit plan, the size of the tax-deductible contribution made to fund retirement income benefits under the plan is calculated annually. The actual deductible contributions are determined by a complex set of mathematical calculations and regulatory requirements, which must be performed by qualified actuaries. Depending on the age of the participants and benefit levels provided, a defined-benefit plan can achieve tax-deductible contributions well in excess of Sec. 415 limits. However, the ability of these types of plans to generate significant contributions also adds to the complexity and reporting requirements. Annual contributions and deductions are calculated each year and are affected by, among other things, actual earnings or losses from investment of the trust assets, actuarial assumptions and limitations imposed by the minimum funding standards and full funding limitations of IRC Sec. 412. As a result, administration costs tend to be higher for these plans then for defined contribution plans. An alternative is to use a Sec. 412(e)(3) plan—referred to in the IRS regulations as an “insurance contract plan”—that is exempt from the funding requirements of IRC Sec. 412. The Fully Insured Plan Solution Sec. 412(e)(3) plans are exempt from the section’s funding rules described above because the burden of providing the benefit is shifted from the employer to an insurance company. Prior to the Pension Protection Act of 2006, these plans were known as 412(i) plans. They are referred to as a “fully insured” plan because the benefits are guaranteed by an insurance company (subject to its claims paying capacity). Fully insured, defined-benefit plans are unique in the retirement planning arena because they have a higher tax-deduction limit than most plans. Moreover, plan contributions may be greater than those made to traditional defined-benefit plans because they are funded using fixed-annuity products. Whole-life insurance may also be included. Also, the interest-rate assumptions are much more conservative in these types of contracts than in a traditional defined-benefit plan. This allows for a greater deduction. While contributions (which are based on guaranteed interest and mortality assumptions) to a fully insured plan generally remain high, they can decrease over time if the assets
A major goal of the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was to encourage the establishment of small-business retirement plans. Since then, as an incentive to small-business owners, the tax-deductible dollar limit and compensation percentage for such plans has increased. In 2008, the maximum contribution limit for defined-contribution plans under IRC Sec. 415(c)(I)(A) is $46,000. Participants at age 50 or more are allowed an additional catch-up limit of $5,000.
ReplyDeleteWhile Sec. 401(k) plans are common, they limit a business’ tax-deductible contributions. Because of recent tax-law changes (provided by EGTRRA and the Pension Protection Act of 2006), which amend the Employee Retirement Income Security Act by establishing new minimum pension funding standards, many companies are eligible for a 401(k) plan, as well as defined-benefit and profit-sharing plans. Your awareness of these changes will enable you to provide new options to your clients.
A defined-benefit plan is a qualified plan where a pre-determined formula sets the amount of retirement income received by a participant. With a traditional defined-benefit plan, the size of the tax-deductible contribution made to fund retirement income benefits under the plan is calculated annually.
The actual deductible contributions are determined by a complex set of mathematical calculations and regulatory requirements, which must be performed by qualified actuaries. Depending on the age of the participants and benefit levels provided, a defined-benefit plan can achieve tax-deductible contributions well in excess of Sec. 415 limits.
However, the ability of these types of plans to generate significant contributions also adds to the complexity and reporting requirements. Annual contributions and deductions are calculated each year and are affected by, among other things, actual earnings or losses from investment of the trust assets, actuarial assumptions and limitations imposed by the minimum funding standards and full funding limitations of IRC Sec. 412. As a result, administration costs tend to be
higher for these plans then for defined contribution plans.
An alternative is to use a Sec. 412(e)(3) plan—referred to in the IRS regulations as an “insurance contract plan”—that is exempt from the funding requirements of IRC Sec. 412.
The Fully Insured Plan Solution
Sec. 412(e)(3) plans are exempt from the section’s funding rules described above because the burden of providing the benefit is shifted from the employer to an insurance company. Prior to the Pension Protection Act of 2006, these plans were known as 412(i) plans. They are referred to as a “fully insured” plan because the benefits are guaranteed by an insurance company (subject to its claims paying capacity).
Fully insured, defined-benefit plans are unique in the retirement planning arena because they have a higher tax-deduction limit than most plans. Moreover, plan contributions may be greater than those made to traditional defined-benefit plans because they are funded using fixed-annuity products. Whole-life insurance may also be included.
Also, the interest-rate assumptions are much more conservative in these types of contracts than in a traditional defined-benefit plan. This allows for a greater deduction. While contributions (which are based on guaranteed interest and mortality assumptions) to a fully insured plan generally remain high, they can decrease over time if the assets