We see sales pitches for fully insured pension plans (aka 412(e)(3) plans – named after the Code Section, and formerly known as and still often referred to as 412(i) plans) quite often. They generally have much higher deductible contributions than more common plan designs, so they seem very attractive for anyone looking to maximize tax deductions.
But are they right…for anyone? Well, a fully insured plan is a kind of defined benefit plan, where the sponsor (employer) makes a promise to provide a monthly benefit at retirement – i.e. an old-fashioned pension plan.
Generally, pension plans require engaging an actuary to determine contributions, but with a fully insured plan, the sponsor (employer) buys contracts from an insurance company that are guaranteed to provide fixed benefits at retirement, bypassing the need for actuarial certification. An important point here is that a “regular” defined benefit plan, which uses an actuary to determine contributions, and a fully insured plan, which is funded through an insurance guarantee, can have the same projected benefits.
So…let’s say you’re a 65 year-old sole proprietor, with no employees. Under certain circumstances (mostly dependent upon your income), you might get a $200,000 maximum contribution for a “regular” defined benefit plan. But a fully insured plan might get you a $250,000 (or more) deduction! That’s great, right? Well, keep in mind that the retirement benefits are the same, so paying more for the same benefit might not be such a great idea after all. Instead of thinking about the contribution as a deduction (to be maximized), think about it as a cost (to be minimized). And there is no doubt about it, fully insured plans are expensive. There is some value to the fact that the insurance company is providing a guarantee, but really, the guarantee is not that expensive and most small employers, especially those looking to set up a “one-man” plan, don’t really care about the guarantee. The rest of the expense is just going to the insurance company and/or agent.
Here’s another way to look at it – if all you care about are deductions, I can charge you $50,000 for “retirement plan consulting” – you get a business deduction for the expense, but you don’t really get anything for it. That’s pretty much how I see fully insured plans.