What was a 412(i) plan — concise definition
– A 412(i) plan was a type of tax-qualified defined‑benefit pension plan used by some small U.S. employers. “Defined‑benefit” means the plan promises a specified retirement payment (for example, a fixed annual annuity), rather than depending on investment returns. “Tax‑qualified” means contributions made to the plan were deductible by the employer under U.S. tax rules.
Key characteristics
– Funding limited to insurance products: only guaranteed annuities and life‑insurance policies could be held inside the plan.
– Immediate tax deduction: employer contributions used to buy the insurance contracts were deductible when made. Employees could deduct contributions where applicable.
– Emphasis on guarantees: benefits were backed by the insurance company’s guarantees rather than by a portfolio of stocks/bonds, so the retirement benefit was effectively fully guaranteed.
– Target users: typically attractive to established, profitable small businesses or owner‑heavy groups that could make large, regular premium payments.
– Regulatory change: the Internal Revenue Service (IRS) replaced 412(i) with the similar 412(e)(3) regime for plans beginning after December 31, 2007, in part because some arrangements had been used for abusive tax avoidance.
Basic jargon (brief)
– Annuity: an insurance contract that converts a lump sum (or series of premiums) into a stream of future payments, often used to provide retirement income.
– Minimum funding requirement: a statutory rule that sets how much must be contributed to a pension plan to meet promised benefits. The 412(e)(3) rules differ from old 412(i) in how this interacts with funding requirements.
Why 412(i) plans existed (and their limits)
– Pros: predictability and guaranteed benefits; immediate tax deductions for employers; simpler investment exposure (insurance contracts rather than market investments).
– Cons: required relatively large insurance premiums, which could strain cash flow; not flexible for businesses that need to reinvest profits; some structures were used to reduce taxes improperly, which prompted IRS action.
Short checklist — what to look for when studying or reviewing a historical 412(i) plan
– Eligibility and coverage: who was covered (owners vs. employees), and were nondiscrimination rules observed?
– Funding vehicle: are plan assets exclusively annuities and/or life insurance policies?
– Timing: was the plan established on or before December 31, 2007, or later (i.e., is it governed by 412(i) rules or 412(e)(3) rules)?
– Deductibility: were employer contributions properly deducted and reported?
– Compliance risks: any signs the arrangement was used to shift income or shelter compensation in ways the IRS later identified as abusive?
– Insurer strength: for guaranteed promises, what is the credit quality of the issuing insurance company?
Simple worked example (illustrative only)
Assume a small corporation wants to provide a guaranteed lifetime annuity for the owner at retirement. An insurer quotes a single premium of $300,000 today to secure that future annuity. The company can deduct that $300,000 contribution on its tax return in the year it is paid, subject to plan rules.
– If the corporation’s marginal federal tax rate is 21%: immediate federal tax reduction ≈ $300,000 × 21% = $63,000.
– Net cash cost this year (ignoring state tax, employer payroll impacts, and future cash needs) ≈ $300,000 − $63,000 = $237,000.
Assumptions and caveats for the example:
– The premium is an illustrative quote—not a market quote; actual premiums vary by insurer, age of participant, annuity terms, and mortality assumptions.
– Deductibility and tax results depend on company type, tax year, and applicable limits; consult plan documents and tax rules.
– Insurance guarantees depend on the insurer’s claims‑paying ability.
Compliance note and regulatory change
– Because several 412(i) arrangements were used in ways the IRS deemed abusive (for example, to create large current deductions without corresponding economic cost), the IRS moved the rules into section 412(e)(3) for plans starting after December 31, 2007. 412(e)(3) plans are also fully insured (insurance contracts fund the benefits) but are treated differently for minimum funding and certain technical requirements. Review current IRS guidance for exact distinctions.
Where to read official guidance and further explanations
– Investopedia — 412(i) definition and overview: https://www.investopedia.com/terms/1/412i.asp
– Internal Revenue Service — Fully Insured 412(e)(3) Plans: https://www.irs.gov/retirement-plans/fully-insured-412e3-plans
– Internal Revenue Service — Employee Plans Abusive Tax Transactions: https://www.irs.gov/retirement-plans/employee-plans-abusive-tax-transactions
– Journal of Accountancy (AICPA) — Journal of Accountancy homepage for practitioner articles: https://www.journalofaccountancy.com
Brief educational disclaimer
This explainer is for educational purposes only. It does not constitute tax, legal, or investment advice. For plan design, tax treatment, or compliance questions about a specific situation, consult a qualified tax advisor, ERISA attorney, or actuarial professional.