Here's how to understand defined benefit plans. IRS allows, up to limits, the amount a business owner can contribute to a plan so that at retirement, he will have enough in his plan to generate an annual income equal to the income they had while working. The annual limit for this type of self employed retirement plan in2008 is $185,000. Because older business owners have less time to build up their plan balance, they can contribute more than younger business owners to reach a particular dollar goal. However, a special type of defined benefit plan, the 412i plan allows contribution that are much larger.
The most powerful plan for maximizing tax deductions for the self employed is a 412i retirement plan. This type of self employed retirement plan may not be a good idea if you have employees. A 412i plan allows you, the self employed individual to generate large tax deductible contributions, enjoy steady, tax-free earnings, while minimizing the amount of contributions that must be allocated to the employees if you have employees.
A 412i self employed retirement plan must be funded with life insurance and annuity contracts—i.e. you cannot invest in mutual funds, stocks, etc. Section 412i allows current contributions to be calculated using the guaranteed cash values and annuity purchase rates of life insurance products. This means that the amounts that a business owner can contribute and deduct are far larger than with other types of self employed retirement plans.
Following is a sample of the maximum deductions available for a 55 year old business owner under different qualified plans:
Comparison of Qualified Plans
Plan Type Owner's Maximum Deduction
Profit Sharing 46,000
Money Purchase 46,000
Traditional Defined Benefit Plan 145,201
412(i) Plan 339,857
Source: 412i plans inc.
Once started, the annual contributions to this type of self employed retirement plan are mandatory. Therefore, the business owner should have a stable cash flow or other source of funds. The 412(i) plan may not be the ideal plan for all situations and businesses. It works best when there are very few employees (less than five); and where the owner is fifty years old or within 10 years of retirement and is older than any of the firm's employees (the amount of tax deductible contribution is limited by the owner's age, the older the owner, the larger the contribution) .
The major disadvantage in this type of self employed retirement plan is the lack of flexibility in investments. The plan must be funded exclusively through insurance contracts in order for all benefits to be guaranteed. On the other hand, this may be attractive if the plan owner also has estate planning requirements for life insurance.
Unlike the plan vanilla defined benefit plan, which require an actuarial calculation annually and are thus more expensive to maintain, a 412(i) self employed retirement plan needs no actuarial certification, as only enough money to provide the guaranteed benefits can be paid to the plan. There can be no over-funding or under-funding problems.
You cannot get this type of plan at a bank or brokerage firm (typically). This type of self employed retirement plan is designed and supplied by an insurance professional or a knowledgeable retirement advisor as part of your retirement income planning and estate planning.
Post provided by Javelin Marketing