Page 1

412(e)(3)

Safe. Stable. Secure. A Tax-Advantaged Retirement Plan with Guarantees

A guide to fully insured defined benefit plans and the large tax-deductible contributions and substantial guaranteed benefits they can provide. By Mary Read CPC, CPFA, QPA and Jim Hiza, CPA


412(e)(3) Safe. Stable. Secure. A Tax-Advantaged Retirement Plan with Guarantees A guide to fully insured defined benefit plans and the large taxdeductible contributions and substantial guaranteed benefits they can provide. By Mary Read CPC, CPFA, QPA and Jim Hiza, CPA

A companion book to My Business is My Main Asset. I Want to Retire. Benefiting From a Plan. By Mary Read CPC, CPFA, QPA https://www.pentegra.com/current-thinking/life-insurance-retirementplans/i-want-to-retire-benefiting-from-a-plan/


© Copyright 2019 All Rights Reserved Mary Read CPC, CPFA, QPA National Director of Pension and Protection Planning Pentegra 802-477-2018 • mary.read@pentegra.com Jim Hiza, CPA Compass Strategies LLC 704-907-1343 • jhiza@compassstrategiesllc.com Pentegra 701 Westchester Avenue, Suite 320E, White Plains, NY 10604 800-872-3473 www.pentegra.com Library of Congress Control Number: 2019938343 ISBN 978-0-578-48334-4


Table of Contents Chapter 1

The Basics of Getting What You Want . . . . . . . . . . . . 3

Chapter 2

Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Chapter 3

Fully Insured 412 (e)(3) Plans . . . . . . . . . . . . . . . . . 11

Chapter 4

Annuities and Guarantees . . . . . . . . . . . . . . . . . . . . 17

Chapter 5

Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Chapter 6

Risk and Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Chapter 7

Benefit Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Chapter 8

Plan Benefit Distribution Choices . . . . . . . . . . . . . . 31

Chapter 9

It’s Time to Take Distributions. Can I Lower the Tax Bill? . . . . . . . . . . . . . . . . . . . . . . 37

Chapter 10 What Does a Third Party Administrator Do? . . . . . 41 Chapter 11 Action Steps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Appendix A Key Dates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Appendix B Code Section 412(e)(3) . . . . . . . . . . . . . . . . . . . . . . 47 Appendix C Taxable Term Cost Table 2001 . . . . . . . . . . . . . . . . 53 Appendix D S & P 500 Returns . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Appendix E COLA Increases . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Appendix F IRS Revenue Procedure 2005 – 25 . . . . . . . . . . . . . 56


Are You Prepared For Reality?

M

ost closely held businesses have no transition plan and maintain no retirement plan.

Consider the following. • 7 in 10 Americans experience some level of anxiety around outliving their retirement savings¹

• 74% of Americans have less than $200,000 saved ²

Two important financial challenges faced by business owners are reducing current tax liability and saving for future retirement. In this book, we will address both.

¹ The 2017 Planning and Progress Study, Northwestern Mutual Life Insurance Company https://news.northwesternmutual.com/planning-and-progress-2018 ² GOBankingRates retirement survey https://www.gobankingrates.com/retirement/planning/why-americans-will-retire-broke/

1


What is Your Plan for Retirement? Think right now. What is your plan for retirement? Income for retirement can come from the sale of a business, from personal savings, from social security and from a private retirement plan. The sale of any business is subject to multiple factors outside of the owner’s control and can be the most unpredictable part of a retirement plan. • When it is time to sell your business, a buyer may not be available. Market conditions may reduce the value of the business. Credit may not be available for a purchaser to get financing. • Personal savings are dependent on personal discipline and on the investment performance of the vehicles in which you invest. • Social Security is a topic of much discussion in today’s environment and may remain intact or may be altered in some way not yet defined. • Private qualified retirement plans were established by the government specifically to enable businesses to create retirement benefits for employees. A qualified retirement plan meets requirements of the Internal Revenue Code and as a result comes with tax advantages and security unavailable in other strategies. Every business owner can establish a private qualified retirement plan to shift assets from their business to their personal wealth.

2


Chapter 1 The Basics of Getting What You Want

What Do You Want? • Do you want to pay more taxes or less taxes? • Do you want the assets you have accumulated to be at risk of being taken away from you or would you rather have them out of the reach of creditors and raiders? • Do you want the IRS to help you accumulate money or stand in the way? If you own your own business, want to pay less taxes, want to protect your assets from the reach of creditors and want to accomplish these things with the help and blessing of the IRS, then you need to step onto a path long established but under-utilized by today’s business owners. That is the path of tax-qualified retirement plans.

3


Qualified Retirement Plans: ➥➥ Tax Deductible ➥➥ Protection from Creditors ➥➥ Retirement Savings Tax-qualified retirement plans were created more than 60 years ago to be a mechanism for providing retirement income for employees. Any employer contributing to such plans benefited from a current tax deduction for every dollar they contributed. Today’s plans do the same, whether you have a business with 1,000 employees or 1 employee. All plan contributions are tax-deductible, grow taxdeferred and are protected for the plan participants from creditors. If you are an employee of your business, you can be a plan participant. Self-employed individuals who file a schedule C and owners of LLCs that are taxed as pass through entities are considered employees. For Subchapter S companies, you are an employee if you receive W-2 income. The money you may pay in income taxes over the next 25 years can translate into substantial savings for retirement! A business owner earning $250,000 annually pays $87,500 each year in taxes*. Over 25 years this equates to $2,187,500 paid in taxes. • If the business adopts a qualified retirement plan and contributes $56,000 to the plan the business owner will save $19,600 in current income taxes. • Over 25 years this equates to $490,000 of tax savings that are instead put to work for the business owner ($19,600 x 25). Assuming a 5% interest rate, the tax savings could grow to more than $935,000 for retirement. • The decision to fund a qualified plan or not is a $1,425,000 decision! You could have $935,451 saved for retirement or pay the IRS $490,000! *35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction

4


$935,451* $800,000

Funding for Retirement

$600,000 $400,000 $200,000 $0 -$200,000 -$400,000

-$490,000

Lost Income Taxes

How Do I Get What I Want? The key to favoring yourself and anyone else you might want to favor in a qualified retirement plan is plan design. Not all qualified retirement plans are equal. There are diverse plan types, and within those types, diverse design tools to steer plan contributions to plan participants in various ways. Qualified retirement plans come in two basic types: Defined Contribution and Defined Benefit. The basic difference is Defined Contribution plans define what will be contributed. Defined Benefit plans define the benefit that will be paid in the future. Plan Type

Defines

Unknown

Defined Contribution

Contribution

Benefit

Defined Benefit

Benefit

Contribution

Defined Contribution Plans define the amount that will be contributed. The benefit a participant will ultimately receive from the plan is unknown. Defined Contribution plans include 401(k) plans and Profit Sharing plans. Think of pulling into the gas station and asking for $20 of gas. You know what you are paying but you do not know precisely how much gas you will get.

*35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction. The numbers assume yearly compounding. A 5% hypothetical return assumed. The illustrated results are not indicative of any particular situation and your results likely will differ from those shown above.

5


Defined Benefit Plans define the benefit a participant will receive at retirement. The contribution will be whatever is needed to fund that benefit as determined by an actuary. Think of pulling into a gas station and saying, “fill it up”. You know you will have a full tank of gas but do not know exactly what it will cost. Hybrid Plans blur the line between Defined Contribution and Defined Benefit Plans by incorporating features of each. Cash Balance plans are currently the most popular of the hybrid plans. The Cash Balance Plan is a Defined Benefit Plan subject to Defined Benefit Plan rules for the maximum and minimum benefit provided and the contributions permitted. The benefit formula defines a benefit comprised of Contribution Credits and Interest Credits credited to a hypothetical account for the participant each year. The plan appears to create an account for each plan participant similar to a Profit Sharing or 401(k) Plan but there is no actual account and the Plan Trustee has full responsibility for investment of the assets. The participant’s final benefit will be the total of the Contribution Credits and Interest Credits credited to their account each year.¹ Different plan types and different formulas will control how much each participant gets of the contribution that is made. Defined Benefit Plans generally have much larger contributions than Defined Contribution Plans. Defined Benefit Plans and some types of Defined Contribution plans will favor anyone who is older and has fewer years until retirement. Other Defined Contribution Plans will divide contributions strictly based on pay. In this book we will look specifically at tax-advantaged Fully Insured 412(e)(3) Plans and the large tax-deductible contributions and benefits they can provide. For a more thorough discussion of all plan types and designs refer to the companion book My Business is My Main Asset. I Want to Retire. Benefiting From a Plan by Mary Read CPC, CPFA, QPA. https://www.pentegra.com/current-thinking/life-insuranceretirement-plans/i-want-to-retire-benefiting-from-a-plan/

¹Subject to minimum funding requirements

6


Chapter 2 Tax Considerations

A

qualified retirement plan meets requirements of the Internal Revenue Code and as a result comes with tax advantages and security unavailable in other strategies. All plan contributions are tax-deductible, grow tax-deferred and are protected from creditors. These tax benefits make qualified plans the most efficient place to save money for retirement. The Tax Cut and Jobs Act of 2017 Section 199A of The Tax Cut and Jobs Act of 2017 provides a new 20 % deduction of qualified business income for certain pass-through businesses. Pass-through entities include: • Sole proprietorships (no entity, Schedule C) • Real estate investors (no entity, Schedule E) • Disregarded entities (single member LLCs) • Multi-member LLCs • Any entity taxed as an S corporation • Trusts and estates, REITs and qualified cooperatives 7


However, personal service businesses lose this deduction when their taxable income exceeds the following thresholds: • $160,700; phased out by $210,700 for single tax payers 2019 (adjusted for inflation) • $321,400; phased out by $421,400 for married filing joint payers 2019 (adjusted for inflation) Section 199A service businesses include the following: • CPA’s • Attorneys • Athletes • Brokers and Agents • Doctors and Dentists • Consultants • Performing Arts The deduction provided by a large qualified plan contribution can bring taxable income below the phase-out threshold in high earning service entities thereby regaining the 20% deduction in addition to the deduction for the qualified plan contribution. SAMPLE SERVICE BUSINESS Mark and Cindy, a married consulting team, are both 60 years old and making $700,000 in combined net income. They file their tax return as married filing jointly. By adopting a Fully Insured 412(e)(3) Plan Mark and Cindy: • Can contribute $405,000 annually • Reduce their current tax liability by $202,360 • Save $1,011,800 in taxes by age 65 • Regain Section 199A deduction of $59,000. Total tax deduction $464,000 ($59,000 + $405,000). • Retire at age 65 with lump sum balances totaling $2,068,140. May elect alternative combined pension income of $170,908 per year. • Acquire $6.4 million in life insurance coverage 8


Mark & Cindy Both Age 60 Married Filing Jointly No Plan Federal Tax Bracket

Plan

37%

24%

$700,000

$700,000

-0

($405,000)

$700,000

$295,000

-0

($59,000)

Standard Deduction

($24,000)

($24,000)

Net Taxable Income

$676,000

$212,000

Taxes Due

$250,120

$50,880

Mark & Cindy Taxable Income 412(e)(3) Plan Deduction

$

Net Mark & Cindy Income 199A 20% Deduction

$

Tax Savings

$199,240

Tax Savings to Age 65 (5 Years)

$996,200

Guaranteed* Annual Pension Income

$170,908

Guaranteed* Pension Lump Sum

$2,068,140

Taxes Due $300,000

$250,120

$250,000 $200,000 $150,000 $100,000

$50,880

$50,000 $-

No 412(e)(3) Plan

With 412(e)(3) Plan

9


No Plan $3,000,000

With Plan $2,068,140

$2,000,000 $1,000,000 $$(1,000,000)

$(966,200)

$(2,000,000)

Lost Income Taxes to Age 65 (5 Years) Guaranteed* 412(e)(3) Plan Balance at Age 65

The adoption of a Fully Insured 412(e)(3) Plan meaningfully reduces the estimated current tax liability and brings their taxable income below the new 199A deduction threshold limits regaining the 20% deduction. The Fully Insured 412(e)(3) Plan also creates significant pension income without market risk.

*Guarantees dependent upon the claims-paying ability of the issuing company. This example is for illustration purposes only. Please consult with your CPA to calculate your tax savings.

10


Chapter 3 Fully Insured 412(e)(3) Plans

➼ Fully Guaranteed* ➼ Large Tax-Deductible Contributions

A

Fully Insured 412(e)(3) Plan is a type of defined benefit plan. Defined benefit plans provide a promised benefit at a specified retirement age. The benefit is defined in the plan document and funding that benefit is the obligation of the employer. The plan participant bears no investment risk and can know at any time what they will receive at retirement. Defined benefit plans can be an effective tool for making large tax-deductible plan contributions and will fund the largest amounts for those closest to retirement.

* Guarantees dependent upon the claims-paying ability of the issuing company.

11


Maximum Annual Benefit

Lesser of: • 100 % high 3 consecutive year average compensation, or • $225,000 per year paid as a life annuity (2019)*

Employer Maximum Tax-Deductible Annual Contribution

No dollar limit. Contributions can be whatever is actuarially required

Maximum Compensation That May Be Recognized

$280,000 (2019)*

*Limits adjusted annually

Business owners will typically consider a Defined Benefit Plan when they want to contribute more than the amount allowed in a Defined Contribution Plan such as Profit Sharing or 401(k) Plan or have a need to accumulate large sums for retirement in a limited amount of time. A Fully Insured 412(e)(3) Plan meets the requirements of Section 412(e)(3) of the Internal Revenue Code (the “IRC”). When a plan meets the requirements of this subsection it is exempt from the funding rules of IRC Section 412 applicable to other defined benefit plans. IRC Section 412(e)(3) requires the plan be funded exclusively with qualifying annuity and life insurance contracts. Fully Insured 412(e) (3) Plans were formerly known as 412(i) plans. Originally established under section 412(i) of the Internal Revenue Code they were moved to Code Section 412(e)(3) by the Pension Protection Act of 2006. Fully Insured 412(e)(3) Plans eliminate market risk because the funding contracts have minimum guarantees. Fully Insured 412(e)(3) Plan can never be over or under funded and the tax-deductible contributions are predictable. A plan participant’s benefit at any time is equal to the value of the underlying contracts. Because funding of the benefits is based on the minimum guarantees in the underlying contracts, Fully Insured 412(e)(3) Plans frequently generate the largest tax-deductible plan contributions. A Fully Insured 412(e)(3) Plan may be a plan solution for the owner of a small business 12


or professional enterprise who desires large current tax deductions and secure guaranteed* retirement benefits. Introducing life insurance to fund a portion of the benefit will provide increased tax-deductible contributions and life insurance benefits complete the plan in the event of pre-mature death. Benefits The Internal Revenue Code (IRC) section that limits the overall plan benefit is Section 415. Section 415 applies to all defined benefit plans in the same way: • The maximum annual benefit is the lesser of 100% of the highest consecutive three years of average compensation (up to $280,000 (2019)), or the IRS limit of $225,000 (2019). The dollar limit is reduced if the actual retirement age is less than age 62. • Individuals may receive the maximum amount available when they reach the Normal Retirement Age defined in the plan. This amount is reduced if it is received prior to that date. • If the benefit is received in the form of a lump sum, IRC Section 417(e) limits apply. This limit is basically the lesser of the limit calculated using the plan actuarial assumptions or the Section 417(e) prescribed interest and mortality. If a Fully Insured 412(e) (3) Plan funds for a maximum benefit payable as an annuity and then pays out benefits as a lump sum, there will be excess funds in the plan. Therefore, the maximum benefits under a Fully Insured 412(e)(3) Plan are usually limited to what can be distributed as a lump sum. Requirements In order for a plan to be exempt under IRC Section 412(e)(3), specific requirements must be satisfied. • The plan must be funded solely by annuity and individual or group whole life insurance contracts that are part of the same series, and that include the same mortality tables and rate assumptions for all participants. To accomplish this the products must be from the same company.

* Guarantees dependent upon the claims-paying ability of the issuing company.

13


• The contracts must fund benefits using level premiums for all benefits. Premiums begin when a participant enters the plan and may extend no later than the Normal Retirement Date specified under the plan. • The plan benefits must be provided only by the contracts and be guaranteed* by an insurance company. SAMPLE Fully Insured 412(e)(3) Plan Annuity & Life Insurance Annual Annual Insurance Lump Sum Contribution Contribution Death at Without Life With Life Benefit Retirement Insurance Insurance

Age

Salary

Owner Pat

61

$280,000

$279,000

$378,181

$3,916,977

$1,327,021

Owner Chris

57

$280,000

$266,330

$335,872

$4,792,439

$2,084,396

Employee 1

27

$45,000

$10,445

$9,856

$786,840

$521,099

$555,775

$723,909

Total

Fully Insured 412(e)(3) Plan After Tax Analysis Total Contribution $723,90 Current Tax Savings* $253,368

Net After Tax Cost $470,541

Contribution for Employee $9,856

Contribution for Owners $714,053

*35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction. The above example is purely hypothetical and for illustration purposes only. The example shown above does not represent the setup of any particular plan and your results likely will differ. * Guarantees dependent upon the claims-paying ability of the issuing company.

14


Advantages of a Fully Insured 412(e)(3) Plan • A Fully Insured 412(e)(3) Plan can provide substantial retirement benefits without market risk. •  Because benefits are funded based on the minium contract guarantees, the Fully Insured 412(e)(3) Plan can provide a maximum current tax-deductible contribution for the business. • No full-funding limitation under IRC Section 404 (a)(1)(A). • No quarterly contributions are required. • There can be no under-funding. Contributions are based solely on the guaranteed provisions* of the level premium contracts. • No actuarial certification is required. •  The accrued benefits for participants are always the cash surrender values of the underlying contracts. •  Generates larger tax-deductible contributions for business owners and employees who are older and higher paid. • Contributions are tax deductible to the business and are not currently taxable to the participants. Disadvantages • Requires contributions that must be made each year. • No policy loans are available. • Participants may not take plan loans.

*Guarantees are based on the claims-paying ability of the insurance carrier.

15


16


Chapter 4 Annuities and Guarantees

I

t is a requirement of IRC 412(e)(3) that each participant is provided with a guaranteed,* predetermined benefit amount that is defined by the plan document and fully insured by the purchase of annuity contracts or a combination of life insurance and annuity contracts. When both annuity and insurance contracts are used they must be from the same insurance carrier. An annuity is a contract between the annuitant and an insurance company. There are two distinct phases to an annuity: 1. The accumulation (or investment) phase 2. The distribution phase The accumulation (or investment) phase is the time period when money is added to the annuity. In a Fully Insured 412(e)(3) Plan this is the period when contributions are made to the plan and deposited in the annuity. The distribution phase is when distributions are made from the annuity.

*Guarantees are based on the claims-paying ability of the insurance carrier.

17


Funding of the Fully Insured 412(e)(3) Plan is based on the minimum guarantees of the underlying annuity and life insurance contracts. The annuity contract used must meet the specific requirements of IRC 412(e)(3). For an insurer to offer any annuity in Fully Insured 412(e) (3) Plans they must take the necessary steps for that annuity to meet the IRC 412(e)(3) requirements. Annuity contracts that do not meet these specific requirements may not be used. In a Fully Insured 412(e)(3) Plan a participant’s benefit under the plan is always equal to the balance in the underlying contract. The underlying contract is guaranteed* by the issuing insurance company, eliminating market risk on the performance of the investments. Distributions from the annuity may be in the form of a lump sum or periodic payments. Because the annuity is inside the Fully Insured 412(e)(3) Plan the plan defines the benefit to be paid and the annuity is the mechanism for making those payments. The annuity may make payments from the Fully Insured 412(e)(3) Plan or the lump sum benefit may be distributed and rolled to an IRA.

*Guarantees are based on the claims-paying ability of the insurance carrier.

18


Chapter 5 Life Insurance

L

ife insurance may be included in any qualified retirement plan (excluding SEPs and SIMPLEs). Including life insurance can make the plan self-completing in the event of pre-mature death. Why Use Life Insurance in a Qualified Plan? •  Deductible employer contributions fund the life insurance premium. If the same life insurance policy were purchased outside of the qualified plan the premium would be paid using after-tax dollars requiring more money to be earned to net the premium amount after taxes. • At the time of death, the beneficiary will receive the current value in the plan account and the death benefit from the life insurance. The “pure death benefit” portion of the life insurance will be paid income-tax free. The “pure death benefit” is the difference between the face amount of the life insurance and the cash value of the life insurance policy. • At retirement, the insurance policy can be transferred to the participant as part of their retirement distribution.

19


• If the participant’s life insurance need has changed at retirement, the life insurance policy can be surrendered inside of the plan and the policy cash value added to their qualified retirement fund account. • Death benefits can self-complete the plan benefit for the insured participant. • A small tax required to be paid annually on the “economic benefit” provided by the policy in the plan may be recovered income taxfree at retirement. Whole life insurance may be included in a Fully Insured 412(e)(3) Plan. Life insurance in all qualified retirement plans must comply with the “incidental insurance” rules discussed in Treasury Reg. Section 1.4011(b)(1)(i). These provisions place a limit on the amount of life insurance that may be purchased under the plan. Generally, a Fully Insured 412(e)(3) Plan can provide no more than 100 times the projected monthly retirement income as a pre-retirement survivor benefit. An alternative provision available under IRS Rev. Rul. 74-307 allows up to two-thirds of the theoretical plan contribution to be used to purchase whole life insurance. This calculation will result in approximately one half of the plan contribution being available to pay for life insurance and the death benefit can exceed the 100 times limit. While life insurance is not required to be included in a Fully Insured 412(e)(3) Plan, this feature does provide additional death benefits for the participant on a pre-tax basis. Including life insurance in the plan will lead to a higher required tax-deductible plan contribution than a Fully Insured 412(e)(3) Plan funded solely with an annuity. Taxable “Economic Benefit” When life insurance is included inside a Fully Insured 412(e)(3) Plan, insured participants must recognize as taxable income the “current economic benefit” of the insurance provided by the plan (Notice 2002-8, 2002-1 CB 398, Treas. Reg. § 1.72-16(b)). Each participant is currently taxed on the “taxable term cost” of the “pure” life insurance benefit. The “taxable term cost” that is reported by the insurance company will be either the IRS Table 2001 cost or a cost based on the company’s alternate term rates. 20


SAMPLE Fully Insured 412(e)(3) Plan* Annual Annual Insurance Lump Sum Contribution Contribution Death at Without Life With Life Benefit Retirement Insurance Insurance

Age

Salary

Owner Pat

61

$280,000

$279,000

$378,181

$3,916,977

$1,327,021

Owner Chris

57

$280,000

$266,330

$335,872

$4,792,439

$2,084,396

Employee 1

27

$45,000

$10,445

$9,856

$786,840

$521,099

$555,775

$723,909

Total

Tax Savings $253,368** • Contribution Increase Over Annuity Only $168,134 ➥➥ $109,287 after tax cost • Insurance Premiums $333,431 ➥➥ $327,165 for owners

* Guarantees dependent upon the claims-paying ability of the issuing company **35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction

21


22


Chapter 6 Risk and Return

M

ajor financial risks to retirement are:

• Living too long • Low stock market returns • Low interest rates • Health care costs Think about your retirement plan. You may have a plan something like the following: • A diversified portfolio among stocks, bonds and mutual funds • Invested for the long-term • Plan to withdraw 4% of your assets during retirement This sounds reasonable but carries a significant amount of risk.

23


The “power of compounding” only works when you don’t lose money. The impact of losses in any given year destroys the annualized “compounding” effect on money. According to Nobel Prize economist Robert Shiller, since 1900 the average bear market drop from the peak to the trough of the stock market has been 44%. When investors lose money in the market it is possible to recover the lost principal given enough time. However, the gain from compounding that could have been achieved during that time can never be recovered. For example, if your investments go down 30% and it takes 20 years to recover your principal you have compounded at a 0% rate of return. You earned your principal back but you did not get the 20 years of investment returns you lost back. Two massive 50% down markets since 2000 have left many investors further away from retirement than they ever imagined. In fact, the average length of time for the stock market to break even after large declines is more than 20 years.

Lance Roberts https://realinvestmentadvice.com/

Over the last 30 years, the S&P 500 averaged 10.16%, while stock market investors only averaged 3.98%*. This underperformance has much to do with emotions and psychology as investors chase returns and experience the fear of losses. Fees and taxes also reduce an investor’s return compared to the index. *Dalbar Study amended May 1, 2017. Returns are for the period ending December 30, 2016

24


Investor Return vs. The S & P 500 10.16%

10.00%

7.68%

6.95% 4.79% 3.64%

3.98%

0.00%

Investor Equity Returns

S & P 500

*Dalbar Study Amended May 1, 2017. Returns are for the period ending December 30, 2016

Social “In-Security” Social Security was designed to replace up to 40% of your pre-retirement income. Concerns about Social Security solvency have arisen as the government has spent the Social Security Trust Fund and there are fewer workers contributing into the Fund while more retirees are drawing from the Fund. The statement below is included on page 2 of your Social Security statement. “Your estimated benefits are based on current law. Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 79 percent of scheduled benefits.” With no guarantees for the future Social Security may not be a reliable source of your retirement income. Health Care Costs Health care costs can devastate the best retirement plans. They can be significantly mitigated with Medicare supplement insurance as well as long-term care insurance.

25


The Effects of Taxes Saving money before taxes enables you to have more dollars put to work for you as compared to saving from the equivalent beginning dollars after taxes. If you had $100,000 in pre-tax dollars (i.e. income) you could deposit the $100,000 in a qualified plan such as a 412(e)(3) plan, or take the money, pay the tax and invest the balance. SAMPLE Assumptions: • Combined income tax rate is 35% • Conservative fixed interest rate for Fully Insured 412(e)(3) Plan 1.75% • Stock index returns gross 7%, net 5.4% after taxes and fees • Fully Insured 412(e)(3) Plan Annual Contribution $100,000 • Investment After-Tax Annual Deposit $65,000 Based on these assumptions, the value of the after-tax investment account will catch up to the Fully Insured 412(e)(3) Plan account in 12 years. If the after-tax investment account experienced one down 10% year the breakeven point moves to 17 years. With one down 35% year the breakeven point becomes 26 years. Break-even Analysis of Pre-Tax 412(e)(3) vs. After-Tax S&P 500 Zero Negative Years Years

26

After-Tax Account

412(e)(3) Account

Year 5-10% Return After-Tax Account

412(e)(3) Account

Year 5-35% Return After-Tax Account

412(e)(3) Account

0

$65,000

$100,000

$65,000

$100,000

$65,000

$100,000

1

$68,510

$101,750

$68,510

$101,750

$68,510

$101,750

2

$72.210

$103,531

$72.210

$103,531

$72.210

$103,531

3

$76,109

$105,342

$76,109

$105,342

$76,109

$105,342

4

$80,219

$107,186

$80,219

$107,186

$80,219

$107,186

5

$84,551

$109,062

$72,197

$109,062

$52,142

$109,062

12

$122,180

$123,144

$104,328

$123,144

$75,348

$123,144

17

$158,929

$134,303

$135,708

$134,303

$98,011

$134,303

26

$255,135

$156,998

$217,857

$156,998

$157,341

$156,998


Review Unfortunately, the ultimate results from what you have planned and projected and what really happens can be two entirely different things. Future retirees dream of a retirement filled with travel, visiting family and friends and volunteer work. Yet they are woefully behind in saving for retirement. • The impact of losses can be greater than the impact of gains • Lost time cannot be recovered • Emotional decisions lead investors to underperform the market • Social Security benefits are not guaranteed • Taxes significantly impact the effectiveness of savings Contribution Comparison - Traditional Defined Benefit Plan vs. Fully Insured 412(e)(3) Plan Plan Contributions

$400,000 $300,000 $200,000 $100,000 $0

1

2 3 4 5 6 7 8 9 10 Traditional Defined Benefit Plan Contribution Fully Insured 412(e)(3) Plan Conribution

Traditional Defined Benefit Contribution

Fully Insured 412(e)(3) Plan Contribution

Year

Age

1

52

$134,575

$218,160

2

53

$208,785

$218,160

3

54

$108,859

$206,823

4

55

$114,570

$220,006

5

56

$253,898

$215,761

6

57

$142,747

$208,582

7

58

$0

$220,635

8

59

$127,553

$203,983

9

60

$316,353

$210,560

10

61

$174,107

$221,318

Annual compensation $200,000

27


Traditional Defined Benefit Plan

Year

Beginning of Year Assets

1

$0

2

Return on Assets

Contribution

3.53%

$134,575

$134,575

-38.49%

$208,785

3

$291,562

23.45%

$108,859

4

$468,792

12.78%

$114,570

5

$643,274

0.00%

$253,898

6

$897,172

13.41%

$142,747

7

$1,160,230

29.60%

$0

8

$1,503,658

11.39%

$127,553

9

$1,802,478

-0.73%

$316,353

10

$2,105,673

9.54%

$174,107

Fully Insured 412(e)(3) Plan

28

Year

Beginning of Year Assets

1

$0

2

Annuity Return on Assets

Contribution

0%

$218,160

$224,705

6.00%

$218,160

3

$467,488

5.56%

$206,823

4

$692,694

3.22%

$220,006

5

$942,480

3.71%

$215,761

6

$1,202,556

4.22%

$208,582

7

$1,451,007

3.05%

$220,653

8

$1,735,969

4.12%

$203,983

9

$2,005,751

3.58%

$210,560

10

$2,279,642

3.00%

$221,318


Chapter 7 Benefit Taxation

A

participant will be taxed on any distributions received as cash from a retirement plan. Distributions from a plan may be made upon retirement or separation from service (IRC Section 402). If the participant is under age 59½, a 10% early distribution penalty will be assessed in addition to income taxes. The premature distribution penalty may not apply if one of the allowable exceptions in IRC Section 72(t) applies. Taxation on distributions rolled into an IRA is deferred until distributions are taken from the IRA. If distributions are delayed taxes will be paid when required minimum distributions (RMDs) commence. All distributions are taxed as ordinary income. When life insurance is provided in a qualified plan there is a current taxable event to the participant known as the “economic benefit.” This is usually the Table 2001 cost (previously known as the P.S. 58 cost) or an alternative rate (insurer term rates applicable to all insureds) that is generally available. The theory of the income taxation of the “economic benefit” is that the participant is currently receiving a benefit (the life insurance protection) under the plan and a current benefit should be taxed as opposed to a future benefit that is deferred. 29


Income-Tax Free Death Benefit Should the insured die before retirement with the life insurance held in the plan, the beneficiary will receive the net death benefit as an income-tax free death benefit. The cash surrender value of the policy is taxed to the beneficiary in the same manner as any other distribution from the plan. The taxable term cost that has been paid may be applied as basis reducing the tax due upon payment of the death benefit or distribution of the policy.

30


Chapter 8 Plan Benefit Distribution Choices

A

t retirement your plan benefit will be distributed. Pension laws require that the normal form of benefit for a single person is a life annuity and for a married person, a joint and survivor annuity. This does not mean the benefit must be taken in this form. The forms that the benefit can be paid in are defined by the plan document. Some might be: • Joint and survivor annuity • Annuity with a period of years guaranteed (term certain) • Lump sum

31


If benefits are going to be paid as an annuity, the plan must remain in effect to make the payments or an annuity that will make the payments must be purchased from an insurance company. It is often preferable to pay the benefit as a lump sum that can then be rolled to an IRA where it can continue to grow tax-deferred. When the plan participant is married, the spouse must consent to the lump sum distribution because they are giving up the plan protection of the survivor annuity. When the accumulated retirement funds are distributed from the plan they are subject to income tax, unless taxation is deferred by rolling the funds to an IRA. The retirement assets are also subject to estate taxes when they apply. Required Minimum Distributions At age 70 ½ Required Minimum Distributions must begin. This rule applies to all traditional and rollover IRAs, SEP and SIMPLE plans and also to all qualified retirement plans. It does not apply to Roth IRAs. Qualified plan participants can postpone taking distributions past age 70 ½ if they are still working. They will need to begin their distributions when they retire. This extension does not apply to owners of more than 5% of the business. Failure to distribute the required minimum amount subjects the individual to an excise tax equal to 50% of the amount they should have distributed but didn’t. The amount that will have to be distributed each year is calculated by dividing an account’s year-end value by the applicable distribution period or life expectancy. Life expectancy factor tables are found in Internal Revenue Service Publication 590. The Required Minimum Distribution rules do not apply to Roth IRAs. For those who have deferred salary into a Roth account within a 401(k), rolling those funds into a Roth IRA will remove them from the Required Minimum Distribution requirement. If the funds stay in the 401(k) Plan they will be subject to the Required Minimum Distribution rules. Early Distributions Amounts distributed from qualified retirement plans or IRAs prior to age 59 ½ are generally subject to a 10% excise tax in addition to any income tax. The 10% excise tax does not apply if the payments are part of a series of payments calculated to be paid over the lifetime of the participant or if the distribution is on account of disability or retirement at age 55 or later. Once started, these payments must 32


continue for a minimum of 5 years and until the recipient achieves age 59 ½, whichever is later. If the distributions are stopped or changed before reaching this goal everything distributed will be treated as distributed before age 59 ½ and be subject to the 10% penalty (IRS Code section 72(t)). Stretch IRA Retirement amounts rolled to an IRA can remain in the IRA until Required Minimum Distributions must begin and can be passed to a beneficiary at death. This strategy is commonly referred to as a “stretch IRA”. The money in the IRA will continue to grow taxdeferred until it is distributed. If the IRA is a Roth IRA there will be no taxes payable on the distributions if the distributions are “Qualified Distributions”. A qualified distribution includes a distribution from a Roth IRA that is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA or made because of death. Annuity Choices A Fully Insured 412(e)(3) Plan includes annuities. At retirement or separation of service the annuity can be surrendered, annuitized, distributed or rolled to an IRA. If the annuity contract is surrendered the cash in the contract can be rolled to an IRA to continue to defer taxation. If the contract is annuitized the contract will pay income to the participant/annuitant for the period elected. All distributions from the annuity contract will be fully income taxable to the recipient. If the contract is distributed to the plan participant/annuitant the recipient can then surrender the contract or take distributions from the contract as they choose. All money will be taxed when distributed from the contract. If the participant/annuitant takes receipt of the contract the contract may be rolled to an IRA if it is written by a company that allows this transfer. This feature is not available on all contracts and availability should be confirmed with the issuing company. Life Insurance Distribution Choices Life insurance cannot continue after the normal retirement date or later if the participant decides to retire at a later date. Depending on the client’s needs at the time there are four choices that he/she will have in deciding what to do with the life insurance. 33


1. The life insurance contract may be surrendered by the plan Trustee. In a Fully Insured 412(e)(3) Plan the cash value of the life insurance policy will be integrated with the annuity. There is no longer a death benefit. 2. Distribute the contract from the plan in-kind if the plan allows for this. The life insurance contract may be distributed intact to the participant. This would be accomplished by the Trustee changing ownership of the life insurance contract from the Trust to the individual. Spousal consent must be attained prior to the distribution. The individual now has a life insurance contract that they own. With this option, there is a taxable event to the individual. He or she will be taxed on the fair market value of the contract. There is no option to defer the tax on the life insurance contract; it may not be transferred to an IRA for further tax-deferral.

Example:

Policy Death Benefit $300,000 Fair Market Value - $100,000 Basis (accumulatedtaxable term costs) - $ 8,000 Taxable Distribution Value $ 92,000

Personal Income Tax*

$ 32,200

3. Purchase the contract from the plan. The plan may sell the contract to the participant if the insurance contract, but for the sale, would be surrendered by the plan. The sale may also be made to a relative of the insured or to a trust or family partnership. The amount paid to the plan for the contract must equal the fair market value of the contract. If the contract is purchased for its fair market value, there will be no tax owed on the transfer. The cash the participant paid for the policy is now part of their retirement benefit and can be distributed or rolled to an IRA along with the rest of their plan benefit.

*35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction. The above example is purely hypothetical and for illustrative purposes only. Your client’s results likely will differ.

34


4. Exchange when offered by insurer. An exchange privilege generally allows the Trustee to surrender the life insurance contract and provide the participant with the availability to maintain life insurance coverage for the net amount at risk (face value – cash value) outside the plan without having to purchase it from the plan. The new policy is issued at current age but with no additional medical underwriting. Fair Market Value (FMV) Whenever a life insurance policy is distributed or sold from a qualified plan its value must be determined. Prior to February 13, 2004, the “value” of a life insurance policy either was the policy’s cash surrender value or in certain cases the policy reserves. However, the IRS grew concerned with the use of what were commonly referred to as “springing cash value” policies that were distributed with very low cash values that would later jump to a much greater amount, thus avoiding taxes at the time of distribution. As a result, after February 12, 2004, the value used for the policy is the “fair market value” which is the policy cash value and all other rights under such contract. Rev. Proc. 2005-25 provides a safe harbor formula for valuing a life insurance policy. The safe harbor value for a policy is “the greater of A or B.” “A” is the sum of the interpolated terminal reserve (a number that must be obtained from the insurance company) and any unearned premiums, plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience. “B” differs depending on the type of policy; it is a formula that can be summarized as “PERC” (Premiums + Earnings - Reasonable Charges) times a certain permitted factor for surrender charges. The formulas basically disallow excessive, waivable, or “disappearing” surrender charges as an offset against value. The “greater of A or B” formula determines the fair market value of the policy. The formula provided by Rev. Proc. 2005-25 is a safe harbor but is not required to be used. Taxpayers may choose to determine fair market value by another method such as getting an appraisal of the policy from an independent company that is in the business of evaluating insurance policies. Determinations not based on the safe harbor can be challenged by the IRS. 35


36


Chapter 9 It’s Time To Take Distributions. Can I Lower the Tax Bill?

M

oney accumulated in a qualified plan or IRA is income taxable at personal rates when it is distributed, whether during life or upon death. Required Minimum Distributions at age 70 1/2 make sure that taxation cannot be deferred indefinitely. The tax treatment cannot be changed. However, there is a unique strategy utilizing the tax treatment of life insurance that can reduce the tax that will be owed. When life insurance is owned and then distributed from a qualified plan it is taxed at its market value, per Rev. Proc. 2005-25. Depending on the life insurance policy used this taxable value can be substantially less than the cash deposited in the policy. Once the policy is distributed from the qualified plan it is personally owned and treated the same as any individually owned life insurance policy. Loans can be taken from the policy to provide tax-free income, the policy will provide an income tax-free death benefit to beneficiaries and some policies provide tax-free benefits for use during lifetime in the event of terminal, chronic or critical illness or critical injury. 37


Profit Sharing or 401(k) Plan Payments to Policy

IRA Rollover

Life Insurance Policy

Rollover Tax Deductible Employer Contributions

$$$ Taxable Distribution P.E.R.C. Rev Procedure 2005-25

Life Insurance Policy Tax Free Income

Tax Free Death Benefit Living Benefits

The life insurance strategy can lower taxes, increase benefits and remove the qualified money from the Required Minimum Distribution requirement.

After-Tax Qualified Money Benefit to Heirs Tax Free Insurance Benefit to Heirs

$ $

650,000 3,166,510

Qualified Money IRA Balance $1,000,000 Tax on IRA

$

350,000

Insurance in Qualified Plan Premiums Paid $ 1,000,000 P.E.R.C. Market Value at Distribution $ 729,834 Tax on P.E.R.C. Market Value

$

255,442

Taxes Saved

$ 94,558

38


Tax Impact* of Waiting Stretch IRA vs. Insurance Distribution Strategy Insurance Total Income Taxes Paid

IRA Total Income Taxes Paid

$2,000,000 $1,800,000

$1,636,792

$1,600,000

$1,422,183 $1,264,080

$1,400,000 $1,087,991

$1,200,000 $1,000,000

$1,549,450

$906,049

$800,000 $600,000 $400,000

$255,442

$255,442

$255,442

$255,442

$255,442

$255,442

$200,000 $0

Age 75

Age 80

Age 85

Age 90

Age 95

Age 100

At the time of this printing proposals pending in Congress could impact required minimum distributions and distribution options for inherited qualified accounts.

*35% estimated combined federal, Social Security, Medicare and state tax rates, married filing jointly tax status using standard deduction

39


40


Chapter 10 What Does a Third Party Administrator Do?

O

nce you have decided that a qualified retirement plan is for you, the plan has to be established and kept compliant with ever changing IRS requirements. There is ongoing testing to be done and there are reports to file. For legal purposes, the Plan Administrator is typically the employer or an officer of the employer. Actual administration of the plan is generally done by a Third Party Administrator (TPA). A TPA is a service provider outside the employer who is hired to perform the administration services of the plan. TPA firms can be large or small. It is important that you choose an administrator you are comfortable working with and have confidence in. Allowing your plan to go out of compliance could result in disqualification of the plan and the disallowance of the tax deductions for plan contributions. TPAs charge fees for their services similar to other professional service providers. Typically, the client signs a service agreement that defines the services and the fees to be paid. 41


The fees paid to the TPA are tax-deductible as a business expense. Additionally, if a plan is the first plan adopted by an employer the government extends a tax credit for startup costs for the first three years of the plan. The credit equals 50% of the costs to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first 3 years of the plan. To qualify for the credit, the employer must have had 100 or fewer employees who received at least $5,000 in compensation for the preceding year. At least one plan participant must be a non-highly compensated employee. The professional you work with to design and fund your plan can usually refer you to a TPA. CPA’s generally do not provide qualified plan administration services beyond a simple one-person plan. A Fully Insured 412(e)(3) Plan is subject to the testing and reporting requirements of other defined benefit plans. The services of a TPA are required to keep the plan in compliance. Third Party Administrator Services ➥➥ Plan Design ➥➥ Document Creation ➥➥ Plan Implementation ➥➥ Administration & Recordkeeping ➥➥ Calculation of Employer Contributions ➥➥ Regulatory Compliance ➥➥ Government Reporting, including Form 5500 ➥➥ Reconciliation of Trust Assets ➥➥ Advisor & Plan Sponsor Reporting ➥➥ Participant Education & Communication ➥➥ Calculation and Processing of Employee Plan Benefit Payments Compliance Should a Fully Insured 412(e)(3) Plan later fail to comply with IRC Section 412(e)(3), it does not automatically become disqualified. It may be converted into a traditional defined benefit plan under Section 412. Due to the large contribution and conservative assumptions used in the fully insured 412(e)(3) Plan, conversion will most likely result in the plan becoming more fully funded. 42


Chapter 11 Action Steps

T

hink about your situation.

• Will you keep your 20% deduction? • Do you want to meaningfully reduce your current tax liability? • Do you want the IRS to help you accumulate assets for your retirement? • Would you like your retirement to have security and peace of mind?

43


Fully Insured 412(e)(3) Plan You can build your Fully Insured 412(e)(3) Plan in these five simple steps. Get ready and begin. Step No. 1:  Define your goals and establish a qualified retirement plan custom designed to benefit you Step No. 2:  Consider protecting your benefit with life insurance Step No. 3: Fund your plan Step No. 4: Make a distribution and wealth transfer plan Step No. 5: Hire a Third Party Administrator Insurance Distribution Strategy You can re-position your qualified distributions to reduce taxes and leverage benefits in these seven simple steps. Get ready and begin. Step No. 1:  Define how much of your current qualified balance you want to dedicate to the re-positioning strategy Step No. 2: Seek out the assistance of Jim Hiza CPA and Mary Read CPC, CPFA, QPA for your best solution Step No. 3: Apply for insurance coverage Step No. 4: Establish or amend your existing 401(k) plan to allow it to own the life insurance Step No. 5:  Hire a Third Party Administrator who can administer the 401(k) plan with life insurance Step No. 6: Pay life insurance premiums Step No. 7:  Distribute life insurance from 401(k) plan at appropriate time and pay taxes due upon the distribution.

44


Contact us to begin the process: Mary Read, CPC, CPFA, QPA Pentegra Retirement Services mary.read@pentegra.com Jim Hiza, CPA Compass Strategies LLC jhiza@compassstrategiesllc.com

45


Appendix A Key Dates

April 15 Last day to return excess deferrals to be taxed in prior year

April 15

Last day for IRA contributions

July 31

Form 5500 due for calendar year plans

September 15  Funding deadline for calendar year Defined Benefit and Money Purchase Plans

October 1 Last day to establish a SIMPLE plan for the current year

October 1 Last day to establish a Safe Harbor 401(k) for the current year

December 31 A new plan must be adopted by the last day of the fiscal year. For most businesses that is December 31. The plan is adopted when the plan document is signed.

46


Appendix B Code Section 412(e)(3) A plan is described in this paragraph if (A) the plan is funded exclusively by the purchase of individual insurance contracts, (B) such contracts provide for level annual premium payments to be paid extending not later than the retirement age for each individual participating in the plan, and commencing with the date the individual became a participant in the plan (or, in the case of an increase in benefits, commencing at the time such increase becomes effective), (C) benefits provided by the plan are equal to the benefits provided under each contract at normal retirement age under the plan and are guaranteed by an insurance carrier (licensed under the laws of a State to do business with the plan) to the extent premiums have been paid, (D) premiums payable for the plan year, and all prior plan years, under such contracts have been paid before lapse or there is reinstatement of the policy, (E) no rights under such contracts have been subject to a security interest at any time during the plan year, and (F) no policy loans are outstanding at any time during the plan year. A plan funded exclusively by the purchase of group insurance contracts which is determined under regulations prescribed by the Secretary to have the same characteristics as contracts described in the preceding sentence shall be treated as a plan described in this paragraph. REGULATIONS SEC. 1.412(e)(3)-1. CERTAIN INSURANCE CONTRACT PLANS: (a) In general. Under section 412(h)(2) of the Internal Revenue Code of 1954, as added by Section 1013(a) of the Employee Retirement Income Security Act of 1974 (88 Stat. 914) (hereinafter referred to as “the Act�), an insurance contract plan described in section 412(e)(3) for a plan year is not 47


subject to the minimum funding requirements of Section 412 for the plan year. Consequently, if an individual or group insurance contract plan satisfies all of the requirements of paragraph (b)(2) or (c)(2) of this section, whichever are applicable, for the plan year, the plan is not subject to the requirements of Section 412 for that plan year. The effective date for Section 412 of the Code is determined under section 1017 of the Act. In general, in the case of a plan which was not in existence on January 1, 1974, this section applies for plan years beginning after September 2, 1974 and in the case of a plan in existence on January 1, 1974, to plan years beginning after December 31, 1975. (b) Individual insurance contract plans.

1) An individual insurance contract plan is described in section 412(e)(3) during a plan year if the plan satisfies the requirements of paragraph (b)(2) of this section for the plan year.

2) The requirements of this paragraph are:

(i) The plan must be funded exclusively by the purchase from an insurance company or companies (licensed under the law of a state or the District of Columbia to do business with the plan) of individual annuity or individual insurance contracts, or a combination thereof. The purchase may be made either directly by the employer or through the use of a custodial account or trust. A plan shall not be considered to be funded otherwise than exclusively by the purchase of individual annuity or individual insurance contracts merely because the employer makes a payment necessary to comply with the provisions of Section 411(c)(2) (relating to accrued benefit from employee contributions). Under the Pension Protection Act of 2006, 412(e)(3) Defined Benefit plans will be re-designated under new IRC Section 412(e)(3) effective 01/01/2008.

(ii) The individual annuity or individual insurance contracts issued under the plan must provide for level annual, or more frequent, premium payments to be paid under the plan for the period commencing with the date each

48


individual participating in the plan becomes a participant and ending no later than the normal retirement age for that individual or, if earlier, the date the individual ceases his participation in the plan. Premium payments may be considered to be level even though items such as experience gains and dividends are applied against premiums. In the case of an increase in benefits, the contracts must provide for level payments with respect to such increase to be paid for the period commencing at the time the increase becomes effective. If payment commences on the first payment date under the contract occurring after the date an individual becomes a participant or after the effective date of an increase in benefits, the requirements of this subdivision will be satisfied even though payment does not commence on the date on which the individual’s participation commenced or on the effective date of the benefit increase, whichever is applicable. If an individual accrues benefits after his normal retirement age, the requirements of this subdivision are satisfied if payment is made at the time such benefits accrue. If the provisions required by this subdivision are set forth in a separate agreement with the issuer of the individual contracts, they need not be included in the individual contracts.

(iii) The benefits provided by the plan for each individual participant must be equal to the benefits provided under his individual contracts at his normal retirement age under the plan provisions.

(iv) The benefits provided by the plan for each individual participant must be guaranteed by the life insurance company, described in paragraph (b)(2)(i) of this section, issuing the individual contracts to the extent premiums have been paid.

(v) Except as provided in the following sentence, all premiums payable for the plan year, and for all prior plan years, under the insurance or annuity contracts must have been paid before lapse. If the lapse has occurred during the plan year, the requirements of this subdivision will be considered to have been met if reinstatement of 49


the insurance policy, under which the individual insurance contracts are issued, occurs during the year of the lapse and before distribution is made or benefits commence to any participant whose benefits are reduced because of the lapse.

(vi) No rights under the individual contracts may have been subject to a security interest at any time during the plan year. This subdivision shall not apply to contracts which have been distributed to participants if the security interest is created after the date of distribution.

(vii) No policy loans, including loans to individual participants, on any of the individual contracts may be outstanding at any time during the plan year. This subdivision shall not apply to contracts which have been distributed to participants if the loan is made after the date of distribution. An application of funds by the issuer to pay premiums due under the contracts shall be deemed not to be a policy loan if the amount of the funds so applied, and interest thereon, is repaid during the plan year in which the funds are applied and before distribution is made or benefits commence to any participant whose benefits are reduced because of such application.

(c) Group insurance contract plans.

1) A group insurance contract plan is described in section 412(e)(3) during a plan year if the plan satisfies the requirements of subparagraph (2) for the plan year.

2) The requirements of this subparagraph are:

(i) The plan must be funded exclusively by the purchase from an insurance company or companies, described in paragraph (b)(2)

(ii) of this section, of group annuity or group insurance contracts, or a combination thereof. The purchase may be made either directly by the employer or through the use of a custodial account or trust. A plan shall not be considered to be funded otherwise than exclusively by the purchase of group annuity

50


or group insurance contracts merely because the employer makes a payment necessary to comply with the provisions of section 411(c)(2) (relating to accrued benefit derived from employee contributions).

(ii) In the case of a plan funded by a group insurance contract or a group annuity contract the requirements of paragraph (b)(2)(ii) of this section must be satisfied by the group contract issued under the plan. Thus, for example, each individual participant’s benefits under the group contract must be provided for by level annual, or more frequent payments equivalent to the payments required to satisfy such paragraph. The requirements of this subdivision will not be satisfied if benefits for any individual are not provided for by level payments made on his behalf under the group contract.

(iii) The group annuity or group insurance contract must satisfy the requirements of clauses (iii), (iv), (v), (vi), and (vii) of paragraph (b)(2). Thus, for example, each participant’s benefits provided by the plan must be equal to his benefits provided under the group contract at his normal retirement age.

(iv) (A) If the plan is funded by a group annuity contract, the value of the benefits guaranteed by the insurance company issuing the contract under the plan with respect to each participant under the contract must not be less than the value of such benefits which the cash surrender value would provide for that participant under any individual annuity contract plan satisfying the requirements of paragraph (b) and approved for sale in the state where the principal office of the plan is located.

(B) I f the plan is funded by a group insurance contract, the value of the benefits guaranteed by the insurance company issuing the contract under the plan with respect to each participant under the contract must not be less than the value of such benefits which the cash surrender value would provide for that participant under any 51


individual insurance contract plan satisfying the requirements of paragraph (b) and approved for sale in the State where the principal office of the plan is located. (v) Under the group annuity or group insurance contract, premiums or other consideration received by the insurance company (and, if a custodial account or trust is used, the custodian or trustee thereof) must be allocated to purchase individual benefits for participants under the plan. A plan which maintains unallocated funds in an auxiliary trust fund or which provides that an insurance company will maintain unallocated funds in a separate account, such as a group deposit administration contract, does not satisfy the requirements of this subdivision.

52

(d) A  plan which is funded by a combination of individual contracts and a group contract shall be treated as a plan described in section 412(e)(3) for the plan year if the combination, in the aggregate, satisfies the requirements of this section for the plan year. [Reg. Sec. 1.412(e)(3)-1.]


Appendix C Taxable Term Cost Table 2001 Interim Table of One-Year Term Premiums For $1,000 of Life Insurance Protection

Attained Age

Section 79 Extended and Interpolated Annual Rates

Attained Age

Section 79 Extended and Interpolated Annual Rates

Attained Age

Section 79 Extended and Interpolated Annual Rates

0

$0.70

34

$0.98

68

$16.92

1

$0.41

35

$0.99

69

$18.70

2

$0.27

36

$1.01

70

$20.62

3

$0.19

37

$1.04

71

$22.72

4

$0.13

38

$1.06

72

$25.07

5

$0.13

39

$1.07

73

$27.57

6

$0.14

40

$1.10

74

$30.18

7

$0.15

41

$1.13

75

$33.05

8

$0.16

42

$1.20

76

$36.33

9

$0.16

43

$1.29

77

$40.17

10

$0.16

44

$1.40

78

$44.33

11

$0.19

45

$1.53

79

$49.23

12

$0.24

46

$1.67

80

$54.56

13

$0.28

47

$1.83

81

$60.51

14

$0.33

48

$1.98

82

$66.74

15

$0.38

49

$2.13

83

$73.07

16

$0.52

50

$2.30

84

$80.35

17

$0.57

51

$2.52

85

$88.76

18

$0.59

52

$2.81

86

$99.16

19

$0.61

53

$3.20

87

$110.40

20

$0.62

54

$3.65

88

$121.85

21

$0.62

55

$4.15

89

$133.40

22

$0.64

56

$4.68

90

$144.30

23

$0.66

57

$5.20

91

$155.80

24

$0.68

58

$5.66

92

$168.75

25

$0.71

59

$6.06

93

$186.44

26

$0.73

60

$6.51

94

$206.70

27

$0.76

61

$7.11

95

$228.35

28

$0.80

62

$7.96

96

$250.01

29

$0.83

63

$9.08

97

$265.09

30

$0.87

64

$10.41

98

$270.11

31

$0.90

65

$11.90

99

$281.05

32

$0.93

66

$13.51

33

$0.96

67

$15.20

53


Appendix D S & P 500 Returns

The annual gain or loss in the S&P 500 Stock index from 1993 to present. Year

54

S&P 500 Return

1993

7.06%

1994

-1.54%

1995

34.11%

1996

20.26%

1997

31.01%

1998

26.67%

1999

19.53%

2000

-10.14%

2001

-13.04%

2002

-23.37%

2003

26.38%

2004

8.99%

2005

3.00%

2006

13.62%

2007

3.53%

2008

-38.49%

2009

23.45%

2010

12.78%

2011

0.00%

2012

13.41%

2013

29.60%

2014

11.39%

2015

-0.73%

2016

9.54%

2017

19.42%

2018

-6.24%


Appendix E COLA Increases for Dollar Limitations on Benefits and Contributions The Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Code ยง415 requires the limits to be adjusted annually for cost-of-living increases. 2019

2018

2017

IRA Contribution Limit

$5,500

$5,500

$5,500

IRA Catch-Up Contributions

$1,000

$1,000

$1,000

IRA AGI Deduction Phase-out Starting at: Joint Return

$103,000

$101,000

$99,000

$64,000

$63,000

$62,000

$600

$600

$600

SEP Maximum Contribution

$56,000

$55,000

$54,000

SEP Maximum Compensation

$280,000

$275,000

$270,000

$13,000

$12,500

$12,500

$3,000

$3,000

$3,000

Single or Head of Houshold

SEP SEP Minimum Compensation

SIMPLE SIMPLE Maximum Contributions Catch-up Contributions

401(k), 403(b), Profit-Sharing Plans, etc. Annual Compensation Elective Deferrals Catch-up Contributions Defined Contribution Limits ESOP Limits

$280,000

$275,000

$270,000

$19,000

$18,500

$18,000

$6,000

$6,000

$6,000

$56,000

$55,000

$54,000

$1,130,000 $225,00

$1,105,000 $220,00

$1,080,000 $215,00

Other HCE Threshold

$125,000

$120,000

$120,000

Defined Benefit Limits

$225,000

$220,000

$215,000

Key Employee

$180,000

$175,000

$175,000

$19,000

$18,500

$18,000

$132,900

$128,400

$127,200

457 Elective Deferrals Taxable Wage Base

55


Appendix F IRS Revenue Procedure 2005 – 25 Internal Revenue Bulletin: 2005-17 See Revenue Procedure for entire text http://www.irs.gov/irb/2005-17_IRB/ar11.html Table of Contents • SECTION 1. PURPOSE • SECTION 2. BACKGROUND • SECTION 3. GUIDANCE FOR DETERMINING FAIR MARKET VALUE • SECTION 4. ADDITIONAL AMOUNTS THAT MUST BE INCLUDED IN INCOME • SECTION 5. EFFECTIVE DATE • SECTION 6. EFFECT ON OTHER DOCUMENTS • DRAFTING INFORMATION SECTION 1. PURPOSE This revenue procedure provides guidance on how to determine the fair market value of a life insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection for purposes of applying the rules of §§ 79, 83 and 402 of the Internal Revenue Code. Rev. Proc. 2004-16, 2004-10 I.R.B. 559, is modified and superseded.

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SECTION 3. GUIDANCE FOR DETERMINING FAIR MARKET VALUE .01 Safe Harbor Formulas for Fair Market Value. This revenue procedure provides two safe harbor formulas that, if used to determine the value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection that is distributed or otherwise transferred from a qualified plan, will meet the definition of fair market value for purposes of § 402(a). These safe harbor formulas will also meet the definition of fair market value for purposes of §§ 79, 83, and 402(b) and, in addition, will meet the definition of vested accrued benefit for purposes of § 402(b)(4)(A). .02 Safe Harbor for Non-Variable Contracts. Except as provided in section 3.03 of this revenue procedure (which applies only to variable contracts), the fair market value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection may be measured as the greater of: A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and B) the product of the PERC amount (the amount described in the following sentence based on premiums, earnings, and reasonable charges) and the applicable Average Surrender Factor described in section 3.04 of this revenue procedure. The PERC amount is the aggregate of: (1) the premiums paid from the date of issue through the valuation date without reduction for dividends that offset those premiums, plus (2) dividends applied to purchase paid-up insurance prior to the valuation date, plus (3) any amounts credited (or otherwise made available) to the policyholder with respect to premiums, including interest and similar income items (whether credited or made available under the contract or to some other account), but not including dividends used to offset premiums and dividends used to purchase paid up insurance, minus (4) explicit or implicit reasonable mortality charges and reasonable charges (other than mortality charges), but only if those charges are actually charged on or before the valuation date and those charges are not expected to be refunded, rebated, or otherwise reversed at a later date, minus (5) any distributions (including distributions of dividends and dividends held on account), withdrawals, or partial surrenders taken prior to the valuation date. 57


.03 Safe Harbor for Variable Contracts. If the insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection being valued is a variable contract (as defined in § 817(d)), the fair market value may be measured as the greater of: A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and B) the product of the variable PERC amount (the amount described in the following sentence based on premiums, earnings, and reasonable charges) and the applicable Average Surrender Factor described in section 3.04 of this revenue procedure. The variable PERC amount is the aggregate of: (1) the premiums paid from the date of issue through the valuation date without reduction for dividends that offset those premiums, plus (2) dividends applied to increase the value of the contract (including dividends used to purchase paid-up insurance) prior to the valuation date, plus or minus (3) all adjustments (whether credited or made available under the contract or to some other account) that reflect the investment return and the market value of segregated asset accounts, minus (4) explicit or implicit reasonable mortality charges and reasonable charges (other than mortality charges), but only if those charges are actually charged on or before the valuation date and those charges are not expected to be refunded, rebated, or otherwise reversed at a later date, minus (5) any distributions (including distributions of dividends and dividends held on account), withdrawals, or partial surrenders taken prior to the valuation date. .04 Average Surrender Factor. (1) Sections 79, 83, and 402(b). The Average Surrender Factor for purposes of §§ 79, 83, and 402(b) (for which no adjustment for potential surrender charges is permitted) is 1.00.

58


Mary Read CPC, CPFA, QPA has more than 30 years of experience designing and establishing qualified retirement plans for closely held businesses. Mary’s expertise has made her a frequent speaker and contributor to financial industry publications. Among her credits she has taught pension classes for financial professionals of major financial institutions and been a featured speaker at national meetings for the Society of Financial Service Professionals, the Association for Advanced Underwriting (AALU), LIMRA, Million Dollar Round Table (MDRT) and the Form 400. Mary continues her active role in supporting financial professionals and closely held businesses with pension strategies in her present position as National Director of Qualified Plan Marketing at Pentegra Retirement Services. Pentegra has over 75 years of retirement plan experience, providing comprehensive retirement plan solutions to businesses, banks and credit unions, and is ranked as one of the top pension providers in the country.

59


Jim Hiza, CPA educates small business owners and CPA’s about the tax deductions and benefits of qualified plans, especially IRC § 412(e)(3) fully insured plans. Additionally, Jim educates CPA’s, closelyheld business owners, tax attorneys and estate planning attorneys on strategies within the IRS Safe Harbor provisions that can reduce taxes and eliminate Required Minimum Distributions from qualified accounts. Previously, Jim spent 20+ years helping individuals, families and institutions with financial planning and investment management. Jim holds a NC CPA license #27254.

60


Pentegra 701 Westchester Avenue Suite320E White Plains, NY 10604 800-872-3473 www.pentegra.com

61


Y

ou can plan for the retirement you want. A Fully Insured 412(e)(3) Plan can provide substantial retirement benefits without market risk. • B  ecause benefits are funded based on the contract guarantees, the Fully Insured 412(e)(3) Plan can provide a maximum current tax-deductible contribution for the business. • T  he accrued benefits for participants are always the cash surrender values of the underlying contracts.

Give yourself the retirement you deserve.

Safe. Stable. Secure.

701 Westchester Avenue, Suite 320E, White Plains, NY 10604 www.pentegra.com • 800-872-3473

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412(e)(3) Safe. Stable. Secure. A Tax-Advantaged Retirement Plan with Guarantees  

412(e)(3) Safe. Stable. Secure. A Tax-Advantaged Retirement Plan with Guarantees  

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