412(e)3 Defined Benefit Plans
A New Twist On An Old Friend
A 412(e)3 Plan is a special type of Defined Benefit Plan. This plan works almost exactly the same way as the typical Defined Benefit Plan, except for one important twist. The benefit in retirement is Guaranteed! That’s right. If you construct a 412(e)3 Plan to provide you with a monthly benefit of $10,000 per month in retirement, it is guaranteed to be at least that high.
The 412(e)3 Plan purchases annuities from insurance companies that offer guarantees of 3%, 4%+ a year. With a 3% return guaranteed, the IRS allows you to use the 3% return in your calculation of future value of the plan. With a regular Defined Benefit Plan, the amount of tax-deductible contributions the owner can make assumes a non-guaranteed return of 5%-7%. However, with a 412(e)3 Plan, the amount of tax-deductible contributions the owner can make is calculated using a much lower 3% return. Because the interest rate is lower, in order to achieve the defined benefit, greater contributions are required (permitted), creating a higher tax deduction.
In fact, 412(e)3 Plans allow significantly more in tax deductible contributions annually. For example, in the situation of a 50-year old described on the page Defined Benefit Plans. the amount one could contribute and deduct with a regular Defined Benefit Plan is $106,000. With a 412(e)3 Plan, however, you could make substantially larger annual tax-deductible contributions ($150,000 a year or more).
Note that your annuities most likely will make more than the 2-3% guaranteed return. But the amount of your contributions is based upon the guaranteed amount. These plans have pumped new life into Defined Benefit Plans, but you must be careful. The IRS has commented on abuses of 412(e)3 Plans, so you need only skilled advisors to guide you through these and other treacherous waters in retirement planning.
Cash Balance Defined Benefit Plans
If you think Defined Benefit Plans sound interesting, you need to learn about the even more powerful and flexible Cash Balance Plan. To learn more, please click here.