The 412(i) plan is a retirement investment option for small-business owners with a high, stable income who need to catch up on adding funds to their retirement savings.
Unlike a defined contribution plan such as a 401(k), which is flexible regarding the amount contributed, the 412(i) is a defined benefit plan. It requires owners to place the predetermined amount, either in a lump sum or incrementally, into the plan each year.
The 412(i) is funded by fixed annuities and insurance, so the 3% return is lower than the return from other retirement investments.
According to Rick Beason of Richard K. Beason CPA, in Roanoke, Va., the IRS allows the amount contributed to a 412(i) to be 100% of an employee's current salary or a specific amount that has a cap. “If you want $165,000 per year when you retire, at 3% earnings, you need to put in X amount now,” Beason says.
The plan covers both owner and employees, and is most advantageous for a baby boomer owner with much younger employees. “Since the plan format is based on how many years [employees] work and how many years they contribute, you will contribute less for a younger person than for an older person,” Beason says. “This is advantageous for the older owner.”
The plan is also good for owners with a small employee base or for those who mostly use subcontractors.
- An actuary does not need to determine your contribution, so it's easy to administer.
- You can contribute more than $50,000 per year to catch up on retirement saving.
- The plan provides life insurance for beneficiaries.
- The plan is not very flexible and the 3% fixed rate is too conservative for some investors.
- Because it is funded by insurance and annuities, most insurance companies will not participate in the plan unless you purchase insurance from them. Because some insurance firms have attempted to manipulate the value, the IRS keeps a close watch on these plans.
Beason says firms that use a reputable insurance company are safe, but suggests that owners should work with a CPA familiar with their finances to determine if a 412(i) is useful for them and to help find a carrier that fits their needs.