What is a 412(e)(3) plan?

A 412(e)(3) plan, once called a 412(i) plan, is a defined benefit plan funded only by individual insurance or annuity contracts. Section 412(e)(3) of the tax code lists the conditions it must meet. A plan that meets them is exempt from the minimum funding rules. A plan that holds market investments is not a 412(e)(3) plan.

The conditions, in plain words

1. The plan is funded only by individual insurance or annuity contracts. (A)
2. The contracts take level annual premiums from the day each person joins the plan until retirement age, at the latest. (B)
3. The plan's benefits are the ones its insurance contracts provide at normal retirement age, and the insurer that issued the contracts is bound to pay them to the extent the premiums have been paid. (C)
4. Every premium is paid before the contract lapses, or the contract is reinstated. (D)
5. No right under the contracts is pledged as security at any time in the plan year. (E)
6. No policy loan is outstanding at any time in the plan year. (F)

Under condition (C), the insurer that issued the contracts is the one bound to pay, and only to the extent the premiums have been paid. This site, an adviser and a government agency do not stand behind the insurer’s contracts.

Yes. The Pension Protection Act of 2006 moved the fully insured plan rule from section 412(i) of the tax code to section 412(e)(3). The IRS says the old provisions were kept and relocated, and the Treasury regulation still carries the old number, 1.412(i)-1, so both names still appear in IRS guidance.

Only insurance company contracts. The IRS says a 412(e)(3) plan must be funded exclusively by the purchase of a combination of annuities and life insurance contracts or individual annuities. Exclusively means exclusively: a plan that also holds stocks, bonds or funds is not a 412(e)(3) plan.

A plan that mixes contracts with market investments is an ordinary defined benefit plan, so the minimum funding rules in sections 412 and 430 apply to it, with an enrolled actuary’s yearly valuation. A plan that buys life insurance must also keep each participant’s death benefit incidental to the main purpose, which is paying retirement benefits.

The yearly contribution is the level premium the contracts require, not a figure an actuary recalculates each year from market results, because the minimum funding rules do not apply. The cost of that is choice: the plan may hold only insurance company contracts, must pay every premium before lapse and may not borrow against or pledge its contracts.

The IRS lists the defined benefit plan as the most costly and the most administratively complex type of plan, and a 412(e)(3) plan is a defined benefit plan. The money is locked until age 59½, separation or plan termination, with a 10 percent additional tax on early distributions. Staff must be covered under federal tests, and the IRS says the right to buy contracts from the plan must be open to all participants in a nondiscriminatory manner. Fees and premiums are paid every year.

The conditions apply plan year by plan year. A plan that misses a premium or takes a policy loan does not meet the statute’s description for that year, and the minimum funding rules then reach it.

The plan type is. Section 412(e)(3) of the tax code describes the plan, and the IRS publishes a page on how its agents examine one. The IRS does list one defined benefit abuse: a plan funded with life insurance or annuity premiums far above what the plan’s benefits need.

In particular, a life insurance death benefit more than $100,000 above the plan’s death benefit is a listed transaction when the employer has deducted the premiums, under Rev. Rul. 2004-20, effective February 13, 2004. A sound plan matches its contracts to its promised benefits and passes nondiscrimination testing.

Is this legal?

Both are defined benefit plans under the same yearly benefit limit and pay limit. A cash balance plan invests a pooled trust, credits a stated interest rate and is valued by an enrolled actuary each year under section 430. A 412(e)(3) plan buys insurance contracts, pays level premiums and is exempt from the minimum funding rules.

The $290,000 figure caps the yearly benefit a plan may pay, not the contribution, and pay counts only up to $360,000 for 2026. The PBGC insures many plans but not all: a professional service employer’s plan that has never had more than 25 active participants at any time after September 2, 1974 is not covered, and neither is a plan maintained only for owners of more than 10 percent of the business.

The tax code draws no dollar line between the two plans. Which one fits depends on the design, the people in the plan and how the owner wants the money held, and an enrolled actuary tests each design on the business’s own census.

What is a cash balance plan?

Not against the plan’s contracts. The tax code requires that no policy loans be outstanding at any time during the plan year and that no rights under the contracts be pledged as security. A policy loan or a pledge in any year means the plan does not meet the 412(e)(3) conditions for that year.

When can I take money out?

A business can amend the plan into an ordinary defined benefit or cash balance plan, which brings in the minimum funding rules and an actuary’s yearly valuation. Or the business can end the plan and pay the contracts, or their value, to the people in it under the plan’s termination rules. Either step follows the plan document.

A life insurance contract that leaves the plan is taxed to the participant at its full fair market value, which counts the policy’s cash value and every other right under the contract. The IRS says so on its page for these plans.

How do I end the plan?

The plan still needs a written plan document, contracts held for the plan, a yearly Form 5500, nondiscrimination testing and premiums paid on time. Federal pension law lets insurance contracts stand outside the trust that other plan assets need. An employee counts as benefiting in a year if a premium is paid on that employee’s behalf.

The Form 5500 is due by the last day of the 7th calendar month after the plan year ends. Missing a premium or taking a policy loan can end the plan’s exemption from the funding rules for that year.

What does a plan cost?

A maximum exists, but the law does not state it plainly for this plan type. The tax code writes its deduction ceiling in terms of the funding rules that a 412(e)(3) plan is exempt from, and the IRS page for these plans refers to a “maximum deductible limit” without defining it.

A contribution above the deductible amount draws an excise tax of 10 percent under section 4972, and the IRS says the tax is charged again each year until the excess is gone. When a 412(e)(3) plan runs beside a 401(k), the combined deduction limit treats it as a defined benefit plan.

Can I keep my 401(k) too?

A 412(e)(3) plan is a pension plan the business sponsors, and the annuity contracts it buys are held for the people in the plan. An annuity you buy yourself is a contract between you and the insurance company. The plan’s rules come with the plan: the business deduction under section 404, the coverage tests for staff and the yearly filings.

Money paid out of the plan is ordinary income to the person who receives it, and a distribution before age 59½ carries a 10 percent additional tax unless an exception applies.