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| By Roger A.
Sebesta, CLU and Suzette W. Jones, CFP |
If your
retirement account is flat lining, or at least trending downward, you might be
able to restore its health through an overlooked, tax-deductible retirement
plan that is also asset protected.
The 412(i) plan was named after the Internal Revenue Code
Section that created it. It is a defined benefit pension plan that has been
around for years. The difference between a defined benefit and defined
contribution plan is simple.
A defined contribution plan is a retirement account
where the amount contributed is fixed and the amount available at retirement is
unknown. The most common types of defined contribution plans are 401(k) and
profit sharing plans.
A defined benefit plan is a retirement account where the amount
received at retirement is known but the amount contributed is not fixed. The
size of the annual contribution is calculated annually and is not subject to
pre-determined limits like a 401(k). The most common types of defined benefit
plans are the traditional pension plans offered by many large corporations and
the 412(i) plan used by small businesses.
Advantages
The 412(i) plan has three major benefits for
physicians: 1) It offers a fully guaranteed retirement benefit; 2) It typically
generates the largest possible retirement plan tax deduction and 3) It is
creditor protected.
Non-guaranteed investments like stocks and mutual funds are not
permitted within a 412(i), only insurance products or fixed-rate annuities. The
advantage is that the retirement benefit is not subject to stock market risk.
This is particularly important to those who have experienced extraordinary
investment losses in their retirement plans and now have a limited amount of
time to make up the lost ground. If you have less than 10 years left until
retirement, you know what we are talking about.
his plan also offers larger
contributions for two reasons. First, it is a defined benefit plan so there is
no fixed dollar limit on the amount that can be contributed in a given year.
The only limitation is on the amount received at retirement, but an advantage
is that you know what that amount is going to be. Second, a defined benefit
plan usually assumes a rate of return in the range of 6-8 percent, while a
412(i) plan is guaranteed in the range of 3 percent. As a result, it is
necessary to contribute more up front to receive a similar return over time.
For this reason, the 412(i) typically experiences a decreasing contribution
requirement as the years go by.
The benefits are also accumulated outside the reach of
creditors. The advantage with the 412(i) plan is that more dollars may be set
aside and protected than with traditional plans. As always, consult with your
attorney for specific advice about asset protection and your individual
situation.
Perfect Fit
Virtually any physician or small business owner can set up a
412(i) plan, but a company that has 10 or fewer employees is ideally suited to
take advantage of the 412(i) plan. Larger businesses might not want the burden
of making contributions for a larger group of employees.
Unlike other retirement plans that
have been criticized in recent years for disadvantaging older participants, the
412(i) plan works best when the business owner or professional is between 40-70
years old, or within 10 years of retirement. When you are less than 10 years
from retirement, you shouldn't expect a lot of asset accumulation from
investment returns because there simply isn't enough time. As you get closer to
retirement, the level of tax deduction becomes more valuable as it often
provides the biggest and quickest return.
This plan works extremely well for those who have
been unable to save much for retirement and for those who perhaps have invested
a lot but suffered losses on their investments. While the equity markets
provide the best historical long-term rates of return and deserve an
appropriate allocation in each investor's portfolio, business owners and
professionals with a short time horizon may sleep better at night with their
retirement secured by a 412(i) plan.
Establishing a 412(i) plan requires an ongoing annual
contribution commitment that cannot be arbitrarily changed on a year-to-year
basis. This characteristic is noticeably different from a profit sharing plan
where plan contributions are at the discretion of the business owner or
professional. For this reason, those considering this plan should have a very
high and stable income.
While this plan is not suited for every professional practice,
under the right circumstances, it has the potential to offer the largest
deduction available in any type of qualified retirement plan. And it does so in
a conservative fashion, as it should be.
There are a variety of strategies and methods
available to help you better prepare for the future. However, the 412(i) plan
is very well suited for physicians and small business owners who are closer to
retirement and are more interested in knowing now what their payouts are likely
to be in the future.
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