Vol 6 No 1		January 2004

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Defined Benefit Pension Plans - Redux

From the frequency of inquiries I have been getting about 412(i) plans it appears life insurance companies have targeted this as a fertile market for its agents. 412(i) plans are defined benefit pension plans that usually use a combination of annuity and life insurance for funding. However, except for a grandslam planning strategy using life insurance in a defined benefit plan - that I identified in my May 2003 AAII Journal column, A Life Settlement Update; and Life Insurance in Pension Plans - life insurance in defined benefit plans is not very attractive, mostly because the grossly high commissions increase the plan's costs. I suspect that it is the decline in the stock market (2000 - 2002) that has encouraged this 412(i) marketing activity, with agents believing that stock market fears would give them traction in selling the defined benefit idea that had pretty much gone into hibernation during the 1990s. Selling frenzies often cause clients to lose sight of the macro issues. Defined benefit plans force participants into potentially underperforming investments (at least from any historical perspective) because fixed-income instruments are almost always used to fund defined benefit plans and better performance causes reductions in funding, not improved benefits. Defined contribution plans on the other hand are free to use equities, market timing and other more free-wheeling investment strategies. Historically, if defined benefit returns have been 5%, and more aggressive defined contribution investment strategy returns have been 9% (geometric average mean), a defined contribution participant could have some 50% more retirement benefits adjusted for all tax implications than a defined benefit participant. Even though the defined benefit tax-deductible contribution is greater its earnings are very likely to be much less.

While doing research for this Perspectives I discovered that abusive 412(i) plans are still stalking the landscape. I had thought they were pretty much put out of business because of the Internal Revenue Service's announcements they are treating them as priorities with possible criminal implications. (See my March 2003 issue of Life Insurance Perspectives.)