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Split-funded plans are a good fit for any type of small business entity - sole proprietorship, partnership, LLC, C-corporation, S-corporation - with one to nine employees, particularly younger employees. The business, however, must have a sufficient cash flow to make required plan contributions.
All contributions to a split-funded defined benefit pension plan are made by the employer. This type of plan is aptly named "split-funded" because the employer contributions are split between a life insurance policy owned by the plan and traditional investments such as mutual funds.
It is important to note the differences between a split-funded plan and a 412(i) plan. In a 412(i) plan, employer contributions must be invested in life insurance, and contributions in excess of the life insurance premium are invested in a fixed annuity. In a split-funded plan, contributions in excess of the life premium are invested in a more traditional pension investment, such as mutual funds.
Benefits to the Business and Business Owner
A split-funded defined benefit plan provides a business owner with long-term retirement accumulations, current life insurance protection, and current business income tax deductions (in the form of plan contributions). This combination of benefits makes the business more tax efficient right now, provides the owner with a guaranteed retirement income, and protects the owner's family with an income-tax-free life insurance benefit if the owner dies prematurely.
Offering this type of plan may also help the business attract and retain talented employees, and the current life insurance protection will often be seen as a valuable benefit by younger employees with families, to whom retirement is too far away to worry about.
Aside from the benefits to the business owner himself, a split-funded defined benefit plan can help small business owners achieve many business objectives while at the same time providing employees with a competitive plan. As a boon to the small business owner, split-funded plan contributions are generally deductible to the business, which can reduce the business's tax burden and make the business more tax efficient.
Benefits to the Employee Participants
A split-funded plan can help preserve participants' financial independence in retirement. When the plan participant reaches retirement, he or she will receive a lifetime retirement income. In today's uncertain economic climate, a lifetime retirement income is invaluable to employees. Upon retirement, the participant may elect to take a lump sum payment, rather than the lifetime income option.
The benefits are not lost, however, if the participant dies prior to reaching retirement. If the participant dies, his or her named beneficiary will be eligible for a pre-retirement death benefit from the life insurance portion of the plan. When an insured participant dies, the net amount at risk - the policy death benefit less the policy cash value - is paid to the named beneficiary. This benefit can be income-tax-free to the beneficiary if the participant has declared the correct amount of economic benefit cost as income each year. This income-tax-free death benefit of the split-funded plan can help provide economic and financial security for the beneficiary, and provide a tangible legacy for surviving family members.
Getting Started
The easiest way to enter this market is through turn-key split-funded defined benefit pension programs offered by a number of major life insurance companies. Contact the carriers you do business with to see if they are in this market. Alternatively, you could contact a pension administrator (TPA) in your area for assistance and technical information.
Rex Ritchie, JD, CLU, ChFC, is the director of advanced markets and qualified plans at Woodbury Financial Services, an independent broker-dealer subsidiary of The Hartford.
He has been in the financial services business for 26 years, specializing in retirement, estate and business planning, and is a frequent speaker and author on industry topics.
While the tax or legal guidance provided is based on our understanding of current laws, the information is not intended as tax or legal advice and should not be relied upon as tax or legal advice. Neither Woodbury Financial Services, Inc., nor its registered representatives or employees, provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.
