412(i) Plan: What It Was and How It Worked

What a 412(i) plan was

A 412(i) plan was a tax-qualified defined-benefit pension plan designed primarily for small-business owners and their employees in the United States. Its defining features:

• Benefits were fully guaranteed.
• Funding was limited to insurance products—guaranteed annuities or a combination of annuities and life insurance contracts.
• Employer (and where applicable, employee) contributions were tax-deductible.

Why it mattered

The plan allowed employers to obtain substantial tax deductions for contributions while providing predictable, guaranteed retirement benefits. That made 412(i) plans attractive to established, profitable small businesses that could commit to high, steady premium payments.

How the funding worked

• Only insurance contracts—individual annuities or annuities plus life insurance—could be held in the plan.
• Premiums were paid to an insurance carrier; the carrier’s contracts produced the promised retirement benefits.
• Because insurance-based funding generally required large, steady premium payments, the structure favored businesses with reliable cash flow.

Limitations and typical users

• High annual premiums made 412(i) plans impractical for startups or businesses with irregular cash flow.
• Best suited to mature, profitable small companies that could consistently fund the required premiums rather than businesses reinvesting most profits into growth.

Compliance problems and regulatory change

Abusive arrangements emerged—notably specially designed life insurance policies that enabled tax avoidance—prompting IRS action. To address these abuses, the IRS moved the 412(i) provisions into section 412(e)(3) for plans beginning after December 31, 2007.

412(e)(3): the successor rules

Section 412(e)(3) preserves the concept of a fully insured, guaranteed benefits plan but imposes strict requirements. Key IRS conditions include:

• Plan funding must consist exclusively of individual annuities or a combination of annuities and life insurance contracts.
• Contracts must provide for level annual premium payments extending to each participant’s retirement age and commencing when the participant enters the plan (or when an increase in benefits takes effect).
• Benefits must equal the contract benefits at normal retirement age and be guaranteed by a licensed insurance carrier to the extent premiums have been paid.
• Premiums for the current and all prior plan years must be paid to prevent lapse, or a policy must be reinstated.
• No rights under the contracts may be subject to a security interest during the plan year.
• No policy loans may be outstanding during the plan year.

Practical considerations

• 412(i) plans are effectively obsolete for new plans established after 2007; any new arrangements must meet 412(e)(3) rules.
• These plans remain niche—useful when a business wants guaranteed, plan-level benefits and can meet significant funding obligations.
• Given complex tax and ERISA implications, employers should consult qualified retirement-plan and tax advisors before adopting or evaluating insured pension alternatives.

Selected reference sources

• IRS guidance on fully insured plans and abusive transactions
• Professional accounting and pension practice literature on Section 412 plans