412(e)(3) Defined Benefit Pension Plans: FAQs
Check out our guide to frequently asked questions about 412(e)(3) defined benefit pension plans. We created this summary to help you determine whether a 412(e)(3) plan may be right for you. Keep reading to find out more.
What is a 412(e)(3) defined benefit pension plan?
A 412(e)(3) plan is a defined benefit pension plan structured under the rules of the IRS tax code Section 412(e)(3). It is also called a “Fully Insured Plan” or an “Insurance Contract Plan”. This type of defined benefit pension plan is funded exclusively by insurance products.
What are the requirements for a 412(e)(3) plan?
The IRS requires that 412(e)(3) plans be funded only by eligible insurance products, either life insurance and annuity, or annuity only. In addition, contracts for a 412(e)(3) plan must include annual, level premiums. Funding for the plan begins when a participant joins the plan and ends at the participant’s date of retirement.
What are the pros and cons of a 412(e)(3) plan?
412(e)(3) plans offer several advantages:
- Guaranteed benefits (as long as annual, level premiums have been paid)
- Tax deductions (determined by out-of-pocket contribution amounts)
- Larger contributions for older employees
- Availability of life insurance with tax-deductible premium
- No stock market risk to the principal
412(e)(3) plans also pose a few disadvantages:
- Require annual funding
- Consistent cash flow needed to fund plan at the beginning of each plan year
- No participant loans are permitted
For many qualified individuals, the advantages of a 412(e)(3) plan outweigh the disadvantages.
Who can use a 412(e)(3) plan?
All business entities are eligible for a 412(e)(3) defined benefit plan, including sole proprietorships, partnerships, C corporations, S corporations, and limited liability companies.
What makes an individual eligible for a 412(e)(3) plan?
Employees become eligible to participate in a 412(e)(3) plan when they reach 21 years of age and have one year of service in which they worked at least 1,000 hours.
How are 412(e)(3) plans funded?
412(e)(3) plans are funded exclusively with annuity and life insurance, or annuity only.
As such, the defined benefits are guaranteed by the contracts once the annual premiums have been paid.
Is there a vesting schedule for a 412(e)(3) plan?
Yes, 412(e)(3) plans do offer a vesting schedule. Many plans use a vesting schedule that requires an employee to work for a specific period before they are 100% vested. If an employee is terminated before they are 100% vested, then the nonvested portion of their account is forfeited and remains in the plan.
Can I take out a loan under a 412(e)(3) plan?
No, the IRS does not allow loans under 412(e)(3) plan rules.
Can I change the contribution formula once I adopt a 412(e)(3) plan?
Yes, if your business cash flow increases or decreases, you can change the contribution formula. However, you must abide by specific timeframes in which the plan can be amended. If more flexibility with contributions is important to you, then you may want to consider a different plan.
Can I skip funding the plan for a year if my business is down?
No, the IRS requires annual funding for 412(e)(3) plans, regardless of changes to your business cash flow.
Can I have a 401(k) plan in addition to my 412(e)(3) plan?
Yes, you can have a 401(k) plan in addition to your 412(e)(3) plan. 401(k) salary deferrals do not impact contributions to a 412(e)(3) plan. Participating in both a 401(k) and 412(e)(3) plan can provide additional retirement savings opportunities.
How do I get started with a 412(e)(3) plan?
If you are interested in getting started with a 412(e)(3) plan, or exploring it as a retirement savings option for you and your employees, get in touch with a trusted financial specialist.
The experts at Honest Buck can help you explore retirement savings plans and choose the right one for your situation.
Contact us to speak with one of our accounting professionals.
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