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Worrying About Retirement? A 412(i) May Be the Answer

By Peter D’Arruda

Perhaps you’re like many small business owners who are nearing retirement and wondering how you’re going to get enough money into your 401(k) so you can actually afford to retire. A few years ago you didn’t have this dilemma, because your portfolio was looking great. But today, it’s a different story. And now that retirement is less than ten years away, you may be getting a little worried.

Or perhaps, despite your best intentions, you neglected to save very much, if at all, for your retirement over the years. In the midst of growing your business, you also had to buy a house and office space, put the kids through college, pay for a wedding or two, and possibly even care for aging parents. In essence, life got in the way of any savings.

Fortunately, there is a solution. Consider starting a 412(i).  Since most people aren’t familiar with a 412(i), here’s how it works: Designed for small business owners with twenty or fewer employees, a 412(i) is a defined benefit plan that allows you to accumulate significant retirement assets in a short period of time. For example, if you’re fifty-five years old and want to retire at age sixty or sixty-five, you could start a 412(i). While meeting with a qualified pension planner, you would determine what amount of monthly income or lump sum you want at retirement. Then your planner can structure a 412(i) that guarantees you’ll get that amount to the penny.

How is this possible? The 412(i) is a fully insured plan, meaning you cannot lose any money you put in. In addition, it is guaranteed to provide a certain minimal interest each year. Any money you contribute goes into a combination of fixed annuities or fixed index annuities, and you may also have life insurance in the plan. Because your contributions are in fixed accounts and fixed life insurance, your planner can “do the numbers” based on interest rates and tell you exactly how much you’ll have when you retire. You are also in effect buying life insurance with a pre-tax dollar.

Before you run out and open a 412(i) for yourself, know the facts of the plan and how to best utilize it.

Who is eligible for a 412(i)? A 412(i) is ideal for small business owners in their peak earning years. Since the plan allows for significant savings, your company or professional practice needs to be highly profitable, and have a steady revenue stream and cash flow. You should also be planning to retire in ten years or less, and seeking a significant income tax deduction to offset your high tax liability.

How much can I contribute to a 412(i)?  Contributions to your 412(i) are based on your age and income. The exact figure you can contribute can be as high as $350,000 per year, depending on your situation. In general, the older you are, the more you can contribute.   If you are incorporated, you can even contribute more than you earn in a year, such as through lottery winnings or inheritances. And every penny you put into the 412(i) is sheltered from taxes, just like your 401(k).

How do I know I won’t lose any money? The 412(i) plan is fully insured. That means it is funded with a combination of life insurance and annuities, or annuities alone. So the guarantees of the 412(i) plan are derived from the life insurance and/or annuity contracts that fund it and are dependent on the claims paying ability of the issuing life insurer. Therefore, you and your planner need to choose reputable companies with superior financial strength. In addition to your money being protected from market fluctuations, it’s also protected from claims or judgments, such as bankruptcy.

What happens when I need the money? The money you contribute to a 412(i), as well as the interest that builds, is tax-deferred. When you retire, you can either draw a monthly income from your 412(i), or you can take the lump sum available and roll it into an IRA account. Any money you draw as income is taxed at your current tax bracket rate. But any money you roll over into a new IRA account is not taxed. You only incur taxes when you actually take the money out for your use.

Why haven’t I heard about this before? Is it really legal? Many CPAs often are not familiar with the 412(i). Those who do know about it remember how the plan was abused in the past, so they don’t recommend it today. After the Stock Market crash in the year 2000, some planners abused the 412(i) by putting more life insurance into the plan than was allowed by law. Since then, the IRS has refined how the plan works. A trained pension professional who specializes in defined benefit planning can give you more advice on this. Bob Falisey, president of Falco Consulting Services, Inc., Los Angeles, CA, who has over 30 years pension experience recently summarized the progression of the 412(i), "The 412(i) section of the Internal Revenue Code has not been well known in the past for several reasons - during the Reagan years taxes were significantly reduced and people were reluctant to use tax-advantaged pensions;  during the Clinton years, stock market performance was excellent and equity products that contain risk are not permitted in this plan. It is now becoming very popular and I see it being used more and more by business owners.”

Get Your Eye on a 412(i): Once small business owners understand the benefits of a 412(i), they can’t wait to establish one. So if you watched your retirement portfolio decline over the past few years, or if you were too busy growing your business and neglected to grow your savings, the 412(i) may be the “second chance” you’ve been hoping for. So start funding a sizable, guaranteed retirement benefit today so you can live the lifestyle of your dreams tomorrow.

Read other articles and learn more about Peter D’Arruda.

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