A 30,000 Foot View of A 412(e)(3) Plan

Understanding 412(e)(3) Retirement Plans: What You Need to Know

When financial advisors call the Retirement Learning Center's Resource Desk, they often have questions about retirement plans, including some technical stuff. Recently, a financial advisor from New York asked about a specific type of retirement plan, which we'll discuss here.

What's a 412(e)(3) Plan?

A 412(e)(3) plan is a unique kind of retirement plan. It's a type of defined benefit plan that's funded by buying life insurance or fixed annuity contracts, or both. The cool thing about these plans is that you don't need an enrolled actuary to figure out how much to contribute each year. These plans are especially good for small business owners who want big tax deductions and a secure retirement income.

Who Should Consider a 412(e)(3) Plan?

These plans work best for small businesses, especially those in professions like law or medicine. Usually, these businesses are small (like, five employees or less), making good profits, and the owner is older than the employees.

What Makes a 412(e)(3) Plan Different?

These plans have some rules to follow, just like other retirement plans. But there are two main differences:

• You can skip the usual rules about putting a minimum amount of money into the plan each year if you meet certain conditions.
• These plans automatically pass a test to make sure employees are getting what they're owed if they meet certain rules too.

What Are the Rules?

Here's a quick rundown of the main rules for 412(e)(3) plans:

• The plan's money has to go into individual annuity or insurance contracts from a U.S. insurance company.
• The contracts have to promise to pay the same amount of money each year until retirement.
• The benefits from the plan have to match what's in the contracts, and they have to be guaranteed by the insurance company.
• You have to keep up with all the payments and not use the contracts as collateral for a loan.
• No loans can be taken out against the contracts.

Things to note

The IRS has seen some violations with these plans, especially ones only funded by life insurance. So, they're watching closely. If you're thinking about one of these plans, it's smart to talk to a tax expert or lawyer first.

In summation

A 412(e)(3) plan is a fancy way to save for retirement with big tax breaks. But it's not for everyone. If you're a small business owner or self-employed, and you're older than your employees, it might be worth looking into. Just make sure you get advice from someone who knows their stuff.