KPM Companies

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412(e)(3) Fully Insured/Guaranteed Pension Plans

YEAR-END PLANNING

 

As the year-end approaches, we want to make you aware of a simple defined benefit plan that can provide valuable benefits and large deductions for your company.  Please read the following commentary and contact us to receive a proposal.  The plan must be adopted by the end of your fiscal year.

 

Recent stock market declines have triggered substantial losses for many retirement plans, leading clients to rethink investment strategies and life insurance companies to tout Fully Insured Pension Plans as a way to protect retirement funds.

 

HOW DO THEY WORK?

 

Fully insured pension plans are defined benefit pension plans guaranteed exclusively by annuity contracts and life insurance.  (Defined benefit plans pay definitely determinable benefits to an employee over a period of years—usually for life—after retirement.) Fully insured pension plans have been around since 1974; in uncertain markets, their guaranteed returns are enticing.  An employer funds such a plan by making annual deductible contributions for eligible workers; the employees are not taxed on the contributions. The plan then purchases from an insurance company annuity contracts with a guaranteed return (generally ranging from 3% to 5%). When a worker retires, the annuity pays an annual retirement benefit taxable to the employee.  The employer can make additional deductible contributions to the plan to purchase life insurance on employees’ lives, to be paid to a designated beneficiary.

 

BENEFITS AND BURDENS

 

Even though these plans have a guaranteed positive rate of return on investment that shifts the risk from the employer/employee to an insurance company, the guaranteed returns are relatively low. The trade-off is elimination of the risk of even lower returns (and possible loss of principal) from investing in the markets.  An advantage to fully insured pension plans is the cost savings employers receive due to the administrative ease of calculating annual contribution amounts. Contributions are calculated using a simple present-value formula based on the guaranteed rate of return, the retirement benefit and the number of years until the employee’s retirement. This eliminates actuarial expenses to calculate yearly contributions.

 

WHO SHOULD ADOPT?

 

Owners of high-earning, stable businesses who want to contribute substantial deductible amounts to their retirement plans will most likely benefit. To achieve the maximum tax benefits, business owners usually should be 50 or older. Because the nondiscrimination, participation and vesting rules typical to retirement plans also apply to fully insured pension plans, businesses with fewer than 10 employees benefit most. (As the number of employees increases, the total cost of contributions rises and the business owner’s retirement goals are potentially hindered.)

 

CONCLUSION

 

The recent popularity of fully insured pension plans is forcing many CPAs and employers to learn more about a provision they hardly ever considered previously. Fully insured pension plans may allow some clients to achieve their retirement goals, while significantly leveraging the deductibility of their contributions and reducing their investment risk. However, such plans are not for everyone. To find out if this plan is appropriate for your company, contact KPM at 877-469-4124.  We will be happy to help.