412(e)(3) Plans for High-Income Business Owners: Benefit Limits, Contributions and How the Strategy Works

Short Answer: What a 412(e)(3) Plan Means for a High-Income Business Owner

For a high-income business owner, a 412(e)(3) plan is a fully insured defined-benefit plan: the business promises a set retirement benefit and funds it only with individual insurance and annuity contracts that meet strict federal conditions. The benefit it may promise is capped by a federal annual limit, and the business may deduct contributions only within federal deduction limits.

This page is for owners, partners and shareholder-employees whose pay is high enough that federal ceilings, not their own compensation, define the plan. It explains what those ceilings mean at high pay, how the contracts fund the benefit, and where the compliance risk sits. Before the Pension Protection Act of 2006, these arrangements were known as "412(i) plans," according to the IRS page on fully insured 412(e)(3) plans.

Why Benefit and Compensation Limits Matter More at High Pay

High pay changes which rule does the limiting. Section 415(b)(1) of the Internal Revenue Code provides that a defined-benefit plan's annual benefit may not be "greater than the lesser of— (A) $160,000, or (B) 100 percent of the participant's average compensation for his high 3 years." Section 415(d) requires the Secretary of the Treasury to adjust the dollar amount annually for cost-of-living increases.

Notice 2025-67 states that, effective January 1, 2026, the section 415(b)(1)(A) limit "is increased from $280,000 to $290,000." For a lower-paid participant, the 100-percent-of-compensation test usually binds first. For an owner whose high-three average pay exceeds $290,000, the 2026 dollar limit becomes the ceiling, whatever the actual earnings.

A separate Code limit also caps the compensation a qualified plan may take into account, and it too is indexed annually. At high pay, a benefit formula therefore runs on capped pay, not actual pay. Because the plan promises a benefit near the ceiling, the contribution needed to fund it can be large, especially when few years remain before retirement. That funding size is the feature high-income owners most often evaluate.

Typical Business Structure for a 412(e)(3) Plan

Sponsorship belongs to the business, not to the owner personally. The plan is maintained by the employer, and its trust qualifies under section 401(a), which describes a trust forming part of a pension plan "of an employer for the exclusive benefit of his employees or their beneficiaries."

Self-employed owners are not shut out. Section 401(c)(1)(A) provides that "employee" includes a self-employed individual. Section 401(c)(3) defines an "owner-employee" as including an employee who "owns the entire interest in an unincorporated trade or business." A sole proprietor's plan benefit is measured against "earned income," which section 401(c)(2) defines by reference to net earnings from self-employment, determined with regard to the section 404 deductions.

Closely held corporations and professional practices organized as professional corporations or partnerships are common sponsors. In such businesses, the owner is often the main participant, so the owner's age and the section 415(b) ceiling largely set the contribution. Professional-licensing and ownership rules for medical, dental, legal and accounting practices vary by state. Fit for owner-only plans and businesses with staff is treated on the site's page on section 412(e)(3) plans.

The Specific Planning Trigger: High Income and a Short Funding Window

The trigger is a combination of high, stable earnings and a limited number of years before a target retirement date. A defined-benefit plan funds a promised benefit by normal retirement age. With fewer years left, each year's funding share is larger, which is why older, high-income owners see the largest contributions.

In a 412(e)(3) plan, those contributions buy insurance contracts. Section 412(e)(3)(B) requires the contracts to provide "for level annual premium payments to be paid extending not later than the retirement age" for each participant, starting when the individual became a participant or when a benefit increase took effect. A compressed window therefore means large, fixed annual premiums.

The IRS has also acted against abusive designs. It issued guidance in 2004 and 2005 "to stop abuses involving the use of certain specially designed life insurance policies in retirement plans," citing Rev. Rul. 2004-20, Rev. Rul. 2004-21 and Rev. Proc. 2005-25, according to the IRS page on fully insured 412(e)(3) plans. Plan design, contributions and deductions for a 412(e)(3) plan need individual review of the plan and contracts by the insurers involved and a qualified tax professional.

How a 412(e)(3) Plan Works for a High-Income Owner-Employee

Mechanically, the business contributes to the plan, and the plan uses those contributions to pay premiums on contracts covering the participant. Treasury Regulation § 1.412(i)-1(b)(2)(i) says 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 plan is described there if:

• (A) "the plan is funded exclusively by the purchase of individual insurance contracts";
• (B) the contracts provide for level annual premiums, as described in the trigger discussion;
• (C) plan benefits "are equal to the benefits provided under each contract at normal retirement age" and are backed, as a contract feature, by a state-licensed insurance carrier "to the extent premiums have been paid";
• (D) premiums for the plan year and all 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"; and
• (F) "no policy loans are outstanding at any time during the plan year."

A plan meeting these conditions is exempt from the minimum funding rules of section 412 under section 412(e)(2)(B). The full walk-through is on the site's page on how a 412(e)(3) plan works.

On deductions, section 264(a)(1) 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." An employer's plan contributions are instead addressed by section 404(a), which provides that pension plan contributions are deductible "under this section," subject to its limits; how these provisions interact for a given plan falls within the individual review of plan design. On death benefits, section 101(a)(1) generally excludes life insurance proceeds paid by reason of death from gross income, subject to the transfer-for-value rule of section 101(a)(2) and, for employer-owned contracts, section 101(j).

Ownership Structure: The Plan Trust, the Employer and the Insured Owner

Four roles sit in the arrangement. The business is the plan sponsor and makes contributions. The plan, directly or through a trust or custodial account, holds the contracts and pays the premiums. The owner-employee is both the insured and the plan participant. The plan's benefit, funded by the contracts, is paid to the participant or, on death, as the plan provides.

Because the owner does not personally own the contracts while they sit in the plan, the owner's rights run through the plan's terms. The IRS page on fully insured plans notes that, where a plan holds life insurance, the amount reported as income "is equivalent to the premium paid on a term life insurance policy for 1 year for the face value of the plan policy."

At retirement, a plan may distribute a contract to the participant or use its value to provide the annuity benefit; either path has tax consequences that turn on the plan's terms and the participant's elections. A distributed contract also raises the question whether the transfer-for-value rule of section 101(a)(2) applies. Section 101(a)(2)(B) excepts a transfer "to the insured," among others. Whether a plan-held contract is an employer-owned contract under section 101(j) depends on the definition and facts of the plan.

Coverage and Funding Considerations at High Income Levels

Funding begins with the benefit, not the policy. An actuary determines the contribution needed to fund the promised benefit by normal retirement age, and the promised benefit may not exceed the section 415(b) limit: $290,000 for 2026 under Notice 2025-67, or 100 percent of high-three average compensation if lower.

Section 404(a)(1)(A) provides that, for a defined-benefit plan other than a multiemployer plan, the deductible amount is "an amount determined under subsection (o)." The site's page on 412(e)(3) plan tax deductions covers that limit.

The insurance face amount is a funding choice inside the plan, sized to the plan's benefit obligations. Rev. Rul. 2004-20 states that employer contributions "used to purchase life insurance coverage for a participant in excess of the participant's death benefit provided under the plan are not fully deductible when contributed," but are carried over to later years within section 404 limits. Insurer forms, procedures, charges and timing vary from insurer to insurer and are confirmed with the insurers involved.

Where the business has other employees, section 401(a)(4) requires that contributions or benefits "do not discriminate in favor of highly compensated employees."