412(e)(3) Plans for Business Owners: Owner-Only Plans, Employees, and Filing

Short Answer: Does a 412(e)(3) Plan Fit a Small Business Owner?

A 412(e)(3) plan can fit a small business owner whose business has stable income and few or no employees, because it is a defined-benefit pension plan funded only with insurance and annuity contracts. Fit turns on three things: whether employees must be covered, whether level premiums are affordable each year, and federal contribution and benefit limits.

This page is written for sole proprietors, single-member LLC owners, partners and owner-employees of closely held corporations who are weighing how to fund their own retirement through the business. The site treats the plan as a business retirement-funding decision in which insurance contracts are the funding mechanism, not the plan itself. Before the Pension Protection Act of 2006, these plans were known as section 412(i) plans, according to the IRS, so "412i plan for small business owners" describes the same structure.

Why a Fully Insured Defined-Benefit Plan Matters for Small Business Owners

The business problem is usually a retirement-funding gap at the owner level. A defined-benefit plan promises a stated retirement benefit, and the employer carries the cost of delivering it. In a fully insured defined benefit plan for small business, insurance contracts carry that promise.

Under 26 U.S.C. § 412(e)(2)(B), the minimum funding standards of section 412 "shall not apply to ... any insurance contract plan described in paragraph (3)." The IRS states that these plans "are exempt from the minimum funding rules" on that basis. The Department of Labor's 2025 Form 5500 instructions add that for a plan funded exclusively by such contracts, "neither the Schedule MB nor the Schedule SB is required to be filed."

The plan remains bounded by federal limits. Contributions are deductible only as section 404 allows, and benefits are capped by section 415(b). This page computes neither for any reader.

How Small Business Ownership Is Typically Structured for This Plan

The sponsor of the plan is the employer, so the business form decides who the employer is and who may count as an employee. A sole proprietorship, a partnership, an LLC, an S corporation and a C corporation each answer that question differently.

The Department of Labor regulation at 29 C.F.R. § 2510.3-3(b) provides that "employee benefit plan" for Title I of ERISA does not include a plan "under which no employees are participants." Paragraph (c) provides that "an individual and his or her spouse shall not be deemed to be employees" of a business "wholly owned by the individual or by the individual and his or her spouse," and that "a partner in a partnership and his or her spouse shall not be deemed to be employees with respect to the partnership." The regulation's own example is a plan covering "only partners or only a sole proprietor."

An owner-only plan therefore sits outside Title I but still has to meet the Internal Revenue Code's qualified-plan rules. Once common-law employees participate, the regulation says the plan "will be covered under title I." Later sections of this page refer back to this owner-only treatment rather than restating it. Professional licensing and ownership rules for practices vary by state.

The Specific Risk or Trigger: When a Business Owner Considers This Plan

Several business situations tend to prompt an owner to look at a 412e3 plan for a small business:

• High, steady profits. The owner may want to put more into a qualified plan than a defined-contribution plan allows.
• A short runway to retirement. For an older owner, the defined-benefit structure may support larger annual funding, still within section 415(b) and section 404.
• A preference for contract-defined values. The benefit rests on insurance or annuity contracts rather than on market results.

Some owners also ask about the life insurance death benefit inside the plan. The IRS issue snapshot discusses an "incidental death benefit rule" and life-insurance taxation rules for these plans. How those rules apply to particular contracts is not something a general page can settle.

In each case the trigger is the retirement-funding problem, and the insurance purchase comes second.

How a 412(e)(3) Plan Works in the Small-Business Context

Mechanically, the business sponsors the plan and pays premiums to the insurer. The plan holds the contracts, and the owner is the insured or annuitant. Treas. Reg. § 1.412(i)-1(b)(2)(i) states that the purchase "may be made either directly by the employer or through the use of a custodial account or trust."

Section 412(e)(3) lists six conditions:

• (A) "the plan is funded exclusively by the purchase of individual insurance contracts"
• (B) the contracts "provide for level annual premium payments to be paid extending not later than the retirement age for each individual participating in the plan, and commencing with the date the individual became a participant"
• (C) plan benefits "are equal to the benefits provided under each contract at normal retirement age" and the statute requires those benefits to be backed by a state-licensed insurance carrier "to the extent premiums have been paid"
• (D) premiums for the year and prior years "have been paid before lapse or there is reinstatement of the policy"
• (E) "no rights under such contracts have been subject to a security interest at any time during the plan year"
• (F) "no policy loans are outstanding at any time during the plan year"

A group contract with the same characteristics may also qualify under regulations.

On deductions, 26 U.S.C. § 264(a)(1) generally provides that no deduction is allowed for "premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary." Employer contributions to a qualified pension plan are governed by section 404, which provides that such contributions, if otherwise deductible, "shall be deductible under this section, subject ... to the following limitations." Section 412(e)(3) plan design, contributions and deductions need individual review of the contracts involved by the insurers and a qualified tax professional.

Ownership Structure: Who Holds the Contracts and Who Is the Beneficiary

Inside the plan, the roles separate cleanly. The plan, directly or through a custodial account or trust, is the owner and beneficiary of the contracts. The owner-participant is the insured, and the business is the premium payer. At retirement, the contracts fund the plan's promised benefit.

The death benefit raises a separate set of rules. Section 101(a)(1) generally excludes from gross income amounts paid "by reason of the death of the insured," subject to the transfer-for-value limit in section 101(a)(2). For an employer-owned contract, section 101(j)(1) generally caps the exclusion at "the sum of the premiums and other amounts paid." That cap lifts only when a section 101(j)(2) exception applies and the written notice-and-consent steps in section 101(j)(4) were met "before the issuance of the contract."

Whether section 101(j) reaches contracts held in a plan depends on the arrangement, which falls within the review already noted. The general rules are covered in how business life insurance works.

Coverage and Funding Considerations: Employees, Contributions, and Limits

Employees change the analysis more than any other single fact. An owner-only plan has no Title I "employees" under 29 C.F.R. § 2510.3-3(b) and (c), as described earlier.

Common-law employees bring Title I coverage with them. They also bring 26 U.S.C. § 401(a)(4), which requires that "the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees." Rev. Rul. 2004-21 holds that a plan funded with life insurance contracts fails section 401(a)(4) where highly compensated employees may buy the contracts before distribution and nonhighly compensated employees' purchase rights "are not of inherently equal or greater value."

Benefits are limited by section 415(b), which caps the annual benefit at the lesser of a dollar amount set in the statute or "100 percent of the participant's average compensation for his high 3 years." The dollar amount that applies to a given plan is confirmed with a qualified professional. Deductions follow section 404.

Funding benefits for employees can change the plan's economics for the owner substantially. Insurer forms, procedures and premiums vary by insurer and are confirmed with the insurers involved.