History and Background of Owner & Professional Benefit Type Plans

Posted on October 3, 2011 by Bill Faiferlick

Qualified owner pension plans have existed in American business for about fifty years. Over time, their usage and accessibility has varied. Understanding their history is important to grasp the business options available today.

In a nutshell…

Originally, Owner Benefit Plans were widely used and popular. Then, for a few decades, Congress tied business owners’ hands regarding personal retirement planning. It took Congress years to wake up to the consequences of their decision. Recent Congressional changes in 2000 opened up again an amazing opportunity for business owners. Suddenly, Congress realized the relationship between meeting the owner’s and the employees’ retirement needs. Both need to be addressed and are interrelated.

The story behind Congressional changes

There are four distinct phases to the history of Owner Benefit Pension development and usage.

Phase I — 1950′s-1974 Owner Benefit Plans freely used.

In the early years, large, publicly-traded companies installed Owner Benefit Plans. Executives received these “golden parachutes” upon their departure. At that time, it simply was not profitable to offer similar benefits to owners of smaller businesses. The plans gave little or only modest protection and benefit to “rank and file” employees.

Phase II — 1974-1985 Congress passed ERISA: Employee Benefits & 412(i) Owner Benefit Plans.

In 1974, all this shifted dramatically. The ERISA (Employee Retirement Income Security Act) law passed. This created great protection to employees, and the consequences for business owners were profound. How did it affect them?

ERISA ushered in a new age of protection for the average employee. It introduced new eligibility rules, changed vesting requirements, imposed limits on contributions (so called “top heavy” rules), mandated a host of reporting requirements, and instituted numerous other rules and regulations governing qualified plans. Since 1974, nearly every succeeding tax act further tightened and restricted an owner’s ability to provide meaningful retirement benefits to themselves with fully deductible contributions to a qualified plan. Increasingly, the owner found himself in a double bind. In order to build personal retirement benefits, he has to provide larger benefits to employees.

However, ERISA had a silver lining in the cloud of employer restriction. It formalized, through the adoption of Code § 412(i), the lesser-known fully-insured defined Owner Benefit pension Plan. This gave business owners, executives, professionals, and highly compensated individual’s tremendous power for retirement preparedness. As never before, they had the ability to receive tax deferrals and retirement plan contributions that resulted in an accelerated retirement account accumulation. These quick accumulations had a positive, profound effect upon owners and principals.

Phase III — 1986-2002 Congress passed Code §412(e), which bound owners’ personal retirement.

In 1986, business owner’s retirement opportunities radically and detrimentally changed. Attempting to control qualified plans and business deductions, Congress passed Code § 412(e). This devastated business owners’ retirement planning. Section 415(e) required very complicated actuarial calculations between defined benefit and defined contribution plans. Establishing or continuing many Owner Benefit Plans became nearly impossible, except for the largest and publicly-traded companies. As a result, most businesses discontinued using these types of plans. They moved to defined contribution plans, 401(k)’s, or no plan at all.

Meanwhile, owners’ frustration and anger grew. Increasingly, the government prevented them from taking meaningful deductions that prepared them for their own retirement. At the same time, many enrolled actuaries [those with the expertise to design and implement Owner Benefit Plans, especially 412(i) plans], either left the profession or retired, out of frustration and inability to adequately practice their trade. The exodus caused a “brain drain,” a great loss of knowledge and expertise beneficial to business owners. Consequently, today there are but a handful of licensed enrolled actuaries in the nation who are capable of this work.

Phase IV — 1999, 2000 Congress repealed Code §415(e): A new era, retirement direction, and opportunity begins for business owners.

Finally, Congress woke up. Following almost two decades of increasing regulation and restrictions to 412(i), Congress realized that small business America was not adopting and funding pension plans. This hurt both employers and employees. Congress also became alarmed because so many “baby boomer” business owners were approaching retirement unprepared and disempowered. With the uncertainty of the social security system, Congress acknowledged that the only way to have highly compensated individuals accumulate enough money for retirement was to allow for proportional deferrals.

At last, Congress acted. They repealed Code §415(e), effective January 2000. Now, business owners again have the ability to take charge of their own retirement needs. But Congress did not stop with that step. In H.R. Rep. No. 107-51, pt.1, Congress states:

“One of the factors that may influence the decision of an employer … to adopt a plan is the extent to which the owners of the business … will benefit under the plan. The Committee believes that increasing the dollar limits on qualified plan contributions will encourage employers to establish qualified plans.”

As a result of this “new” thinking in Congress, several modifications to existing rules and new rules were passed under the Economic Growth and Tax Reconciliation Act of 2001 (EGTTRA-2001.) These new rules took effect on January 1, 2002, and marked the beginning of a new era in pension planning for business owners and professionals.

Under these new rules, business owners and professionals again have a powerful retirement opportunity through Owner Benefit Plans. The opportunity is possible as long as modest benefits are offered to employees that qualify for plan inclusion under some design formatsUsing specialized actuarial methods, it’s possible for owners to place into their personal retirement accounts between 85% and 92% of all contributed deferred dollars.