Section 412(e)(3) Plans
How a 412(e)(3) Plan Works: Insurance Contracts, Level Premiums and the Plan Benefit
Published October 9, 2026 · Updated October 9, 2026
Short Answer: What a 412(e)(3) Plan Does
A 412(e)(3) plan is a defined-benefit retirement plan that a business funds exclusively with insurance or annuity contracts meeting six conditions in 26 U.S.C. § 412(e)(3). The contracts provide for level annual premium payments extending not later than each participant's retirement age, starting when the individual became a participant, and the plan's benefits equal the benefits provided under each contract at normal retirement age. Employer contributions may be deductible under section 404, subject to its conditions and limits, and section 415(b) limits the benefit.
How 412e3 plans work comes down to the statute's six conditions and the limits that apply to contributions and benefits. The IRS notes that before the Pension Protection Act of 2006 these were known as "412(i) plans," so a reader asking how a 412i plan works is asking about the same structure. The section 412(e)(3) plan overview covers the definition. This page explains the mechanics.
Planning Objective: The Business Problem This Plan Addresses
The starting point is retirement income for the people who own and run the business. An owner-employee with fewer years before retirement has fewer years in which to build a retirement benefit. A defined-benefit plan states the benefit first and then funds it. A fully insured version funds that benefit through insurance or annuity contracts rather than an invested portfolio.
The insurance is the funding mechanism, not the plan. The plan is a qualified retirement plan with its own document, participants and rules. The contracts carry the funding obligation. Section 412(e)(3)(C) ties the plan's benefit to "the benefits provided under each contract at normal retirement age." Any deduction for that funding stays within section 404, and section 415(b) limits the benefit.
How the Structure Works: Contracts, Premiums and the Plan Benefit
A plan funded by individual insurance contracts is described in section 412(e)(3) if it meets all six of its 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." Payments start on the date the individual became a participant, or, for a benefit increase, when the increase takes effect.
- (C) Plan benefits equal the contracts' benefits at normal retirement age and, under the statute, are backed by an insurance carrier licensed under the laws of a State to do business with the plan, to the extent premiums have been paid. That carrier backing is a contract feature the statute describes, and it reaches only as far as premiums have been paid.
- (D) Premiums for the current plan year and all prior plan 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."
The statute also treats a plan funded exclusively by group insurance contracts as described in the paragraph if regulations find that those contracts have the same characteristics. Under 26 C.F.R. § 1.412(i)-1, the employer may buy such group contracts "either directly by the employer or through the use of a custodial account or trust." The IRS states that these regulations "were not updated after the enactment of PPA '06 and remain in Treas. Reg. Section 1.412(i)-1." The old numbering does not change the current law in section 412(e)(3).
Under section 412(e)(2)(B), these plans are exempt from the minimum funding rules of section 412. The 2025 Form 5500 instructions add that when a plan is funded exclusively by such contracts, "neither the Schedule MB nor the Schedule SB is required to be filed."
Parties Involved: Employer, Plan, Participants and Contracts
Four parties appear in every arrangement:
- The employer. It sponsors the plan and makes the contributions.
- The plan. Rev. Rul. 2004-20 gives an example in which the plan holds life insurance and annuity contracts for the benefit of a participant. For group contracts, 26 C.F.R. § 1.412(i)-1 says the purchase "may be made either directly by the employer or through the use of a custodial account or trust."
- The participant. This is the employee or owner-employee whose life or annuity benefit each contract covers.
- The insurance carrier. It issues the contracts and backs the benefit to the extent premiums have been paid.
Employer contributions fund the premiums. Who receives a death benefit and how the plan uses contract values depend on the plan's terms and the specific contracts.
Two federal rules turn on who owns a policy and who benefits from it. Section 264(a)(1) allows no deduction for premiums "if the taxpayer is directly or indirectly a beneficiary under the policy or contract." Section 101(j) limits the death-benefit exclusion for employer-owned contracts. Whether section 101(j) notice and consent, or Form 8925 reporting, applies to contracts held by a particular plan needs individual review by the insurers involved and a qualified tax professional.
Who This Is For: Situations Where a 412(e)(3) Plan May Be Considered
The structure is relevant to employers that sponsor, or are weighing, a defined-benefit plan funded exclusively by insurance contracts. Section 412(e)(3)(B) requires the contracts to provide for level annual premium payments extending not later than each participant's retirement age, so cash flow that can carry those payments every year is the first fact to examine.
For an owner-employee closer to retirement, the arithmetic is simple: a stated benefit spread over fewer years of level premiums requires a larger premium each year.
Workforce size matters because section 412(e)(3)(B) speaks of level premium payments "for each individual participating in the plan," so each additional participant adds premium obligations. Rev. Rul. 2004-21 holds that a plan funded in whole or in part with life insurance contracts does not satisfy section 401(a)(4) where highly compensated employees may purchase those contracts from the plan before distribution and the purchase rights of nonhighly compensated employees are not of inherently equal or greater value. The plan is a qualified defined-benefit plan, not a personal life-insurance arrangement or a savings account.
When It May Fit: Factual Conditions That Support This Structure
Fit generally turns on whether the business can meet the statute every year without exception. The factual conditions usually examined are these:
- Cash flow. The business has enough steady cash flow to keep every premium paid before lapse, which section 412(e)(3)(D) requires.
- Time horizon. The owner-employee has enough years before normal retirement age for level premiums to fund a meaningful benefit.
- Existing plans. Defined-contribution plans are already in place, and the owner is evaluating additional retirement funding within section 404 and section 415(b).
- Preference for a stated benefit. The owner places more weight on a benefit stated in the contract than on a benefit that moves with investment results.
- Workforce size. The workforce is small enough that the cost of covering eligible employees is manageable for the business.
None of these conditions settles the question by itself. Each one feeds a plan-specific design analysis.
We're Here for You
We're your trusted California business life insurance advisor. Call us 7 days a week, or send us a message, to have a real conversation about what your business needs.
When It May Not Fit: Factual Conditions That Limit This Structure
Some businesses find the structure too rigid. Revenue that swings from year to year conflicts with the fixed premium schedule in section 412(e)(3)(B). It also conflicts with the requirement in (D) that premiums be paid before lapse.
A large eligible workforce raises the total cost. A younger owner with many years before retirement may find that level premiums spread over a long period produce smaller annual funding than other designs.
Liquidity is another constraint. Section 412(e)(3)(E) and (F) require that no rights under the contracts have been subject to a security interest and that no policy loans are outstanding at any time during the plan year, so using the contracts as collateral or borrowing against them would take the plan outside section 412(e)(3).
Because the plan is funded exclusively by contracts, its assets are limited to what those contracts provide. If premiums cannot be sustained, amending or terminating the plan carries its own tax and legal consequences, which depend on the plan's facts.
Tax Treatment: Contributions, Deductions and Benefits
The deduction rule comes first. Section 264(a)(1) allows no deduction for premiums on a policy when the taxpayer is directly or indirectly its beneficiary. Employer contributions to a pension plan fall under section 404(a), which provides that, "if they would otherwise be deductible, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year." How the two sections interact in a particular design depends on the plan's terms.
Rev. Rul. 2004-20 states that employer contributions under a qualified defined benefit plan that are used to buy life insurance coverage for a participant in excess of the participant's death benefit under the plan "are not fully deductible when contributed." The ruling adds that those amounts are carried over to be treated as contributions in future years, and are deductible in a future year only when the other contributions taken into account for that year are less than the maximum amount deductible under the section 404 limits.
Section 415(b)(1) limits the annual benefit to the lesser of "$160,000" or "100 percent of the participant's average compensation for his high 3 years." The $160,000 is the base figure written in the 2024 edition of the Code; section 415(d)(1)(A) directs the Secretary to adjust that amount annually for increases in the cost of living, so the dollar limit that applies is the adjusted figure for the plan year involved. The statute also adjusts the limit when benefits begin before age 62 or after age 65.
Retirement distributions are generally taxed under the rules for qualified-plan distributions. Any death benefit raises the section 101(a)(1) exclusion and its business-planning limits:
- the transfer-for-value rule in section 101(a)(2), and
- section 101(j), which caps the exclusion for an employer-owned contract at premiums and other amounts paid. The cap is lifted only when a section 101(j)(2) exception applies and written notice and consent were given before issuance.
Each of these rules turns on how the plan's contracts are owned and designated.
Potential Advantages: What the Structure Provides Under Federal Rules
Section 412(e)(2)(B) exempts a plan described in section 412(e)(3) from the minimum funding rules of section 412. The 2025 Form 5500 instructions confirm that a plan funded exclusively by such contracts files neither Schedule MB nor Schedule SB.
The benefit is stated by the contracts and backed by the carrier "to the extent premiums have been paid." It is not tied to an investment portfolio.
Shorter funding periods can produce larger annual contributions, still within section 404 and section 415(b). Section 404(a)(1)(A) addresses contributions paid into a tax-exempt pension trust, which is the qualified-plan framework the structure operates within. The contribution limits page explains how the benefit limit drives the premium.
Important Considerations: Compliance, Abusive-Plan History and Ongoing Obligations
The IRS states that 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.
Under Rev. Rul. 2004-20, a plan cannot be a section 412(i) plan if its contracts provide benefits at normal retirement age that exceed the participant's benefits under the plan. The IRS also treats one arrangement as a "listed transaction": an employer deducting premiums on a contract whose death benefit "exceeds the participant's death benefit under the plan by more than $100,000." Arrangements of this kind remain on the IRS's listed-transaction list and are not a planning strategy.
A plan funded by individual insurance contracts that misses any of conditions (A) through (F) is not described in section 412(e)(3). It then does not get the exemption in section 412(e)(2)(B) from section 412's minimum funding rules.
Section 412(e)(3) plan design, contributions and deductions need individual review of the contracts involved by the insurers and a qualified tax professional. Premiums, contract terms and features vary by insurer and are confirmed with the insurers involved. The six statutory conditions are covered in more depth on their own page.
Tax and Legal Coordination: What Professionals Review in This Structure
Several disciplines usually work on one plan. These typically include a plan administrator, a tax professional and a licensed insurance professional. Together they test the plan document against the qualification requirements and match the contract premiums to the benefit formula.
Three calculations are run on the actual plan and participant group:
- the section 404 deduction limit,
- the section 415(b) benefit limit, and
- the premium schedule that sits between them.
The death-benefit questions under section 101(a)(1), section 101(a)(2) and section 101(j) are part of the same ownership review described for the parties involved. Insurance rules governing the contracts vary by state and are confirmed with the insurers involved.
Alternatives: Other Plan Structures That Address Similar Objectives
Comparisons usually begin with a conventional defined-benefit plan. A conventional defined-benefit plan that is not funded exclusively by insurance contracts is not described in section 412(e)(3), so section 412's minimum funding rules apply to it.
A cash balance plan expresses the defined benefit as a hypothetical account balance.
A 401(k) profit-sharing plan is a defined-contribution plan, and section 412(e)(2)(A) excludes profit-sharing plans from section 412.
The site has separate comparison pages on 412(e)(3) plans versus conventional defined-benefit plans, cash balance plans and 401(k) plans.
Example (Hypothetical): How Level Premiums Fund a Stated Benefit
The figures in this example are hypothetical round numbers for illustration only. They are not any reader's result, and they name no insurer or product.
Assumptions:
- One participant enters the plan 15 years before a normal retirement age of 65.
- The participant's average compensation for the high three years is $200,000.
- The contracts call for a level premium of $100,000 per year.
- The contracts provide a $180,000 annual benefit at age 65.
- The employer's computed section 404 deductible amount for the first year is $90,000.
Step 1: Total premiums. $100,000 × 15 years = $1,500,000, paid on the level schedule that section 412(e)(3)(B) describes.
Step 2: The section 415(b) cap. For this illustration, assume the applicable dollar limit is the statute's base figure of $160,000, before the section 415(d) cost-of-living adjustment. The cap is then the lesser of $160,000 and 100% of $200,000, which is $160,000. A $180,000 contract benefit exceeds it by $20,000. A plan benefit of that size would fail the section 415(a)(1)(A) condition for a qualified trust, and contract benefits above plan benefits also run into Rev. Rul. 2004-20. In this illustration the design would be reduced to fit within the cap.
Step 3: The section 404 deduction. $100,000 contributed − $90,000 deductible = $10,000 not deductible in year one.
Actual premiums, benefits and limits depend on the contracts, the participant's age and compensation, and the plan's terms.
We're Here for You
We're your trusted California business life insurance advisor. Call us 7 days a week, or send us a message, to have a real conversation about what your business needs.
Frequently Asked Questions
What does 'fully insured plan' mean under section 412(e)(3)?
It means a plan funded exclusively by insurance contracts that meet all six conditions of section 412(e)(3)(A) through (F). Those conditions cover level premiums, benefits backed by the carrier, premiums paid before lapse, no security interests and no outstanding policy loans. The site's page on life insurance inside a 412(e)(3) plan covers the contracts themselves.
What is the difference between a 412(e)(3) plan and a 412(i) plan?
Section 412(i) is the former name for these provisions. The IRS states that the former section 412(i) provisions "were retained under PPA '06 but were relocated to IRC Section 412(e)(3), effective for plan years beginning after December 31, 2007." The site has a separate page on the former 412(i) name.
Is a 412(e)(3) plan a life insurance policy or a retirement plan?
It is a qualified defined-benefit retirement plan. Insurance or annuity contracts are the funding mechanism the plan holds. The plan itself is not a life insurance policy, a savings plan or an investment account.
How are contributions to a 412(e)(3) plan deducted?
Employer contributions may be deductible under section 404 if they would otherwise be deductible, subject to that section's limits. Amounts above the limit are not deductible in the year paid. Under Rev. Rul. 2004-20, contributions used to buy life insurance coverage above the participant's death benefit under the plan are not fully deductible when contributed; they are carried over and are deductible in a future year only when other contributions for that year are less than the maximum amount deductible under section 404. The site's page on 412(e)(3) tax deductions explains the limits further.
Does a 412(e)(3) plan require an actuarial valuation?
A plan funded exclusively by qualifying contracts is exempt from section 412's minimum funding rules. The 2025 Form 5500 instructions state that such a plan files neither Schedule MB nor Schedule SB. A plan that misses any condition loses that treatment.
What is the section 415(b) limit and how does it affect a 412(e)(3) plan?
Section 415(b) limits a participant's annual benefit to the lesser of $160,000 (the base figure in the 2024 edition of the Code, which section 415(d) directs the Secretary to adjust annually for cost of living) or 100% of average compensation for the high three years. The statute also adjusts the limit for benefits starting before age 62 or after age 65. A plan benefit cannot exceed the cap, whatever the contracts provide.
What happens if a 412(e)(3) plan fails to meet the statutory requirements?
It is no longer described in section 412(e)(3), so the section 412(e)(2)(B) exemption from section 412's minimum funding rules does not apply. Separately, the IRS treats an arrangement in which the employer deducts premiums on a life insurance contract with a death benefit that exceeds the participant's death benefit under the plan by more than $100,000 as a listed transaction, as Rev. Rul. 2004-20 describes.
Who owns the life insurance contracts in a 412(e)(3) plan?
Rev. Rul. 2004-20 gives an example in which the plan holds the contracts for the benefit of a participant, and for group contracts Treas. Reg. § 1.412(i)-1 says the purchase may be made "either directly by the employer or through the use of a custodial account or trust." Who receives any death benefit depends on the plan's terms and the contract designations, and ownership affects the tax analysis.
Educational information only. Not legal, tax, investment or insurance advice. Product availability and outcomes depend on individual circumstances.