I spoke
at the American Society of Pension Actuaries national convention in Washington
in Oct, 2002 about plans, as did the IRS chief actuary. People were warned of
IRS attention to these abusive plans. After I spoke I was invited to the IRS
headquarters where I addressed IRS senior officials. Treasury dept officials
were also listening on speakerphones. We discussed problems, and the IRS future
action against abusive plans. Within a few years IRS developed task forces that
started to audit abusive plans.
Below is
an article published in 2003 that I did not author about the 2003 ASPA
convention.
Pending
Guidance on 412(i) Plans Discussed at ASPA Convention - November 3, 2003
The IRS discussed pending guidance on fully insured defined
benefit pension plans under §412(i) at its "Aggressive Practices"
session last week at the annual American Society of Pension Actuaries (ASPA)
conference in Washington, D.C.
The Treasury/IRS reiterated its concerns relative to the
aggressive marketing of policies to fund 412(i) plans with
"springing" cash value schemes (as previously addressed in IRS Notice
89-25) and atypically high death benefits that exceed the incidental life
insurance limits. These issues were discussed in detail in our March 28,
2003 article: 412(i) Plan: A "Dream" or
"Nightmare" for the Small Business Owner? Which was referenced in the Tax Exempt and
Government Entities Division (TE/GE) Advisory Committee Report on Abusive Tax Shelters released on May 20, 2003 (also view IRS Recognizes Milberg
Consulting as Pension Compliance Advocate).
The pending guidance is expected to identify abusive, or
potentially abusive 412(i) plan designs. These abusive arrangements will
likely be designated as "listed transactions" under tax shelter
rules. The IRS representatives at the conference made it clear that the
pending guidance is not intended to affect those properly designed 412(i) plans
that are funded with conventional life insurance contracts (absent
"springing" cash values and atypically high death benefits).
The really bad news for those who
have adopted a plan funded with policies that fall under this scrutiny is that
the pending guidance is expected to be retroactive.
Commentary
Let's face the facts... all of the schemes involving the sale of
life insurance products that attempt to take advantage of the
"loopholes" in the laws governing qualified retirement or welfare
benefit plans were created to make the cost of life insurance more palatable to
the consumer, typically the owners of small businesses. Each and every
one of these imprudent schemes in the past 20 years involving VEBAs (§501(c)9),
the so-called "pension rescue or pension crush plans," §419 plans,
life insurance sub trusts and most recently, §412(i) plans are eventually shut
down by the IRS.
We are mindful that our view is biased in that we earn our living
by providing plan design and compliance services associated with traditional
defined benefit and defined contribution plans on a fee for service
basis. We also believe that most business owners have legitimate needs
for life insurance, and that a life insurance contract created by reputable
company and sold by a reputable agent can serve as an invaluable planning tool
for the small business owner.
As to those §412(i) plans which in theory fit within the pending
IRS guidance, we simply do not believe that most life insurance agents and
their home offices have the expertise to determine if a defined benefit pension
plan in any form or fashion is the appropriate plan type for their small
business clients. We routinely receive calls from referring
professionals inquiring relative to the applicability of a defined benefit plan
for their small business clients. In the vast majority of instances, a
defined benefit pension plan is simply not the proper solution.
The one thing for certain about the future is that it brings
change. Therefore, the potential for change in the owner's desire for
tax-sheltered benefits is a reality that must be considered during the planning
process. In the context of a traditional defined benefit plan, a change
of this nature could lead to a cutback in benefits to mitigate plan
costs. It might even necessitate the termination of the plan resulting in
a distribution of the owner's accrued benefit into an IRA. In the context
of a fully insured defined benefit pension plan under §412(i), changes in the
plan's benefit structure or plan termination could leave the small business
owner with the continued expense to maintain a superfluous life insurance
policy or an unanticipated taxable event.
Using a §412(i) plan in the context of an owner only business with
a legitimate need for the death benefit protection provided by life insurance
may be an appropriate place for this plan type. However, we believe that
until such time that the uniform estate tax credit is unlimited (which is
currently subject to change), a traditional defined benefit plan along with a
conventional life insurance policy held within an irrevocable life insurance
trust (ILIT) is a more prudent choice for the small business owner. While
this plan design may cost more than a 412(i), it provides the small business
owner with a significantly higher probability for a positive outcome and the
flexibility to address change in the future.
Bottom Line: In theory the §412(i) plan provides a small business owner
with a retirement plan that provides significant benefits on a tax deductible
basis absent the complications typically associated with a traditional defined benefit
pension plan. In reality, this plan type is rarely appropriate for owners
of small businesses.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
