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Why 412(i) Plans Are Bad News !!!

​Almost every physician-investor has been pitched the 412(i) defined-benefit plan. At least once they've been told how it's the greatest income tax reduction plan for small business owners today. If you purchased a 412(i) defined-benefit plan in the past few years as a tax shelter, however, you could be in a world of trouble.

Popular Pitch Sinks

Let's discuss how the 412(i) plan works. If a physician- investor puts $250,000 into a 412(i) plan every year for 5 years as a tax-deductible expense, they'll eventually fund $1.25 million over that period. The cash surrender value (CSV) of the policy at the end of the 5th year will be $250,000. The physician-investor will then purchase the life policy from the 412(i) plan for that $250,000 CSV and think they got a great deal since the cash account value (CAV) of the policy is really $1.1 million. After waiting for surrender charges in the life policy to evaporate, they will take income tax–free loans from the policy.

Buying a policy with a low CSV and a high CAV seems like a steal of a deal since the investor only pays 20% of the value of the asset when they purchase it out of the 412(i) plan. This was supposed to save the investor 80% of the tax on that money. If this sounds too good to be true, it didn't to many physician-investors who allowed insurance agents to sell them 412(i) plans. After looking at the plan, the IRS eventually shut it down. Ironically, the beginning of the end of 412(i) plans started on Friday, Feb. 13, 2004.