What is a 412E3 Fully Insured Defined Benefit Pension Plan?

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Defined benefit pensions under the Internal Revenue Code Section 412(e)(3), also known as 412e3 plans, offer small business owners tremendous overlooked benefits and deductions for setting up a fully insured defined benefit retirement pension. Benefits that are so substantial, deductions that are so tremendous that it amazes me that more tax advisers and wealth managers don’t offer to help their clients with these type of plans.

 

Public sector employees fight tooth and nail for the right for pension benefits because they are familiar with and have these plans and they know the benefits. Maybe after reading this article, the small business owner might find a new substantial way to mitigate taxes and take advantage of this little known tax code.

 

Most consumers have heard of a 401K plan, which is a more popular plan considered a defined contribution plan. A defined contribution is an opportunity to contribute to a retirement plan while deferring taxes to a later date. With a pension plan there is a defined benefit at the end of the day, so there is a GUARANTEED RETIREMENT AMOUNT at the end of the day set aside for retirement.

 

So what exactly is a 412e3 fully insured defined benefit pension plan and why is it better than a 401K or any other tax deferred account?

 

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1. A 412e3 Defined Benefit Pension is one of the most tax-efficient vehicles available to a small business owner.

 

The Internal Revenue Code Section 412(e)(3) “guarantees” a defined benefit. A fully insured 412e3 defined benefit pension made available to the small business owner with less than 5 employees allows tremendous deductions unavailable in any other plan. Inside a defined benefit pension we can deduct for Federal and State income taxes, Medicare taxes, Social Security taxes and also Obamacare taxes. Whew! Meanwhile, a 401K can’t deduct for Medicare or Social Security which turns out to be giving away 15.3% to Medicare and Social Security.

 

Make note of that important number. When saving for retirement for 10, 20, or 30 years, giving away 15% in taxes annually multiplied by 20 or 30 years might make anyone’s head explode! But we are not done yet! With Obamacare, for successful people earning over $200K, there is an additional 3.5% tax. Plop that money into the pension and deduct it instead.

 

2. Is a Defined Benefit Pension a lower cost than a 401K?

 

A fully insured 412e3 defined benefit pension plan is less expensive. Why? Because its funding mechanism is via a major insurance company who guarantees all the benefits, the lump sum, the lifetime income and death benefit. Since this is a guaranteed product there is no need for compliance to annually review the plan (which costs money), as the insurance company manages and administers the plan for a nominal fee. This is a fully insured plan with a defined benefit. This means the consumer knows the end result at the onset. The consumer should also love the fact that pensions have a huge bureaucratic backing with the pension benefit guarantee corporation as well as the state guarantee fund wherever they live. I am not familiar with any protection with a 401K.

 

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3. Liability is shifted away from employers with a fully insured 412e3.

 

A lot of small employers set up a 401K without analyzing the risk involved. A 401K is made up partially of employee funds to create a defined contribution plan, so the employer has to be bonded as a fiduciary. By doing so, they are liable for errors and could also be liable for the platform they set up. With a fully insured 412e3 defined benefit pension, the benefit is guaranteed by the insurer.

 

4.  A fully insured defined benefit pension creates asset protection.

 

Think of a malpractice suit, or a slip and fall on a property, residence or business. The conservative financial products made up inside a pension are outside the estate of the insured and therefore are litigation proof (minus a divorce in some circumstances.)  It’s impossible to find a more aggressive asset protection tool than saving money inside insurance products like life insurance.

 

5. Fully insured 412e3 defined benefit pensions allow gigantic six figure deductions.

 

The funding vehicles used to finance these pensions are extremely conservative life insurance products; therefore, they can take large contributions to create the outcome necessary. For any successful business owner, an annual need of $200,000 is not out of the question and over 20-30 years of retirement could require 3 to 4 million dollars to fund.

 

The optimal number for a salary to maximize contributions is $210K this year. Anything above that won’t help in terms of how much more can be contributed in the plan, because in the Internal Revenue Code that is the maximum considered compensation. By the way, anything below hurts.

 

So, with the 412e3,  if the annual income is higher, the spread is deferred in the pension plan to reduce the effective tax rate. The Net Effect is to function like corporate entities who are taxed at 35% with an effective rates of 12.1%. These corporate entities have wicked smart tax attorneys and advisers to find deductions. However, small business owners will pay a lot more than 12.1%. This is because they don’t always look for ways to mitigate their taxes. They don’t bother to look for pensions to reduce liabilities.

 

There is nothing necessarily wrong with a current 401K. However, if there was a way to save 15% – avoiding Medicare and Social Security taxes plus the 3.5% Obamacare tax – have a lower cost to administer the plan, have less risk, a larger annual deduction, and create instant asset protection, why wouldn’t more consumers investigate the advantages of tax codes like IRC 412e3? It was created to benefit the small business owner.

 

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Is a 412e3 Defined Benefit Pension an Overlooked Retirement Plan? | Goldsmith Insurance Agency