Boosting Retirement Plan Limits

Retirement plans, especially defined benefit plans, used to be a great deal for professionals and small business owners. A successful business owner could sock away large deductible contributions in his account each year.

But sharp limits were put all pension plan contributions in the 1980s, and defined benefit plan contributions were targeted for the most restrictions. That reduced the use of pension plans by many small business owners.

Now there is a way to greatly increase the annual contribution limits for defined benefit pension plans. For example, a 50-year-old can make a maximum contribution of about $65,000 annually (depending on the assumptions) under the regular rules. But one type of plan would allow a contribution of about $86,000. For a 60-year-old the contribution would be $110,000 under a standard plan and $167,000 under another type of plan.

The plan that lets you increase the limits is a 412(i) plan, also known as a fully insured plan or insurance contract plan.

The limits on contributions can be increased under a 412(i) plan if the plan is funded exclusively with individual insurance contracts, such as life insurance or annuities. There also must be level annual premium payments every year until retirement age. There cannot be any loans from the plan, and the insurance contracts cannot be pledged as security. The amount of the insurance contracts must be equal to the full benefits promised under the plan. Dividends and interest from the contracts must be applied to the next year’s contribution, which can make the contributions partially self-funding.

Perhaps best of all, you don’t need expensive and complicated actuarial calculations to determine the benefits and contributions under the plan. Only the guaranteed rates of return from the insurance contracts are used to determine the amount of funding. You don’t need an actuary to determine the right rate of return to use.

Since the actual returns are likely to exceed the guaranteed returns from the contracts, you actually are likely to end up with higher benefits than were estimated. Based on past insurance industry practices, you could end up with a benefit that is 50% or more greater than the estimated amount.

When the requirements of section 412(i) of the tax code are met, the plan is not subject to full funding attacks from the IRS. In fact, if you have a plan now that is vulnerable to a full funding problem, you might be able to convert it to a 412(i) plan.

Here’s a little bonus. As of this year, you can combine an insurance contract plan with a defined contribution plan without lumping the two together to determine maximum benefits.

To accumulate a large retirement plan in a hurry with maximum tax benefits, get more details about the plans from your insurance broker and your corporate attorney or accountant.