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A very hot business-planning topic today is the 412(i) qualified retirement plan. The reason is, these plans are providing exceptionally large tax deductions for contributions to a qualified plan.
What’s behind the buzz is the subject of my article today. Before exploring this plan, let’s review what 412(i) plans are and are not.

A 412(i) plan is a defined benefit qualified retirement plan. It is based on section 412(i) of the Internal Revenue Code. The IRC mandates that these plans must be funded with insurance contracts, either life or fixed annuity, guaranteed by an insurance company.

While such plans are subject to the normal rules that govern other defined benefit plans, the contributions for older employees can be considerably higher than allowed for in traditional defined benefit and/or defined contribution (401k profit sharing) plans. This is because the benefits can be funded using the minimum guaranteed interest rates of life and annuity contracts. This lower minimum guaranteed rate generates significantly higher tax deductions

Now, for what 412(i) plans are not: They are not 419 plans or VEBA (Voluntary Employment Beneficiary Associations) plans, both of which have come under a great deal of IRS scrutiny.

Who will most benefit from a 412(i) plan? In general, small businesses with twenty (20) or fewer employees are best suited for these plans, with one or two person businesses being ideal. Excellent prospects are high earning small business owners, doctors and real estate agents who have relatively stable and predictable earnings.

Note: Larger firms can benefit from 412(i) plans as well, but the plans are not as attractive for them because contributions to such plans must be made for all employees.

412(i) plans have been around for over 40 years, but they fell out of favor when the 1990’s bull stock market made defined contribution plans look more attractive, due to the high investment returns they were generating in the market at that time.

Today’s uncertain economy and stock market, has brought 412(i) plans back into favor; and they are now more popular than ever. The benefits they offer – dramatically increased tax deductions and secure guaranteed investment results – are exactly what business owners are looking for right now.

What’s more, the Economic Growth and Tax Relief Reconciliation Act of 2001 has created the potential for even higher contributions and deductions in all defined benefit plans, including the 412(i) plans. This, too, has helped to make these plans more attractive than ever.

How so? EGTRRA introduced several changes that have combined to boost tax deductions for business owners sponsoring 412(i) plans. The EGTRRA changes include: an increase in the maximum compensation used to determine benefits from $170,000 to $200,000; an increase in the maximum dollar limit for pensions from $140,000 to $160,000; and removal of any reduction on the dollar limit on benefits for participants retiring between age 62 and 65.

Today 412(i) plans provide clients, especially older clients, the largest contribution to a qualified plan, bar none!

For example, a 55-year-old consultant, using a retirement age of 62, could make a maximum contribution of $42,000 into a traditional profit sharing plan; or a $188,209 maximum contribution into a traditional defined benefit plan. But this consultant’s maximum tax-deductible contribution into a 412(i) plan could be as much as $332,357. Thus, if the consultant is in a 40% tax bracket, his income tax bill is lower, by over $130,000, due to the 412(i) plan.

Also, in this example, the 412(i) plan provides a contribution that is substantially higher than a traditional 401(k) profit sharing plan. See the chart below for other examples.

Maximum Contributions – Plan Comparison (2002 Limits) Age Retirement Age Traditional 401(k) Profit Sharing Traditional Defined Benefit 412(i) Plan 45 62 $40,000 $75,000 $145,236 50 62 $42,000 $128,166 $236,305 55 62 $42,000 $188,209 $332,357 60 65 $42,000 $194,847 $338,216

The 412(i) plan is very conservative. All asset accumulation rates and retirement benefits are fully guaranteed. This means these plans are safe from stock market fluctuations and are not influenced by economic down turns. They provide the added diversification that a traditional equity based portfolio needs to smooth out future investment performance.

The guaranteed rates in the insurance contracts that typically fund 412(i) plans are very competitive given today’s historically low interest rates. Current guaranteed rates will range from 4.5 to 5% and returns will average in the 6.25 to 7% range as interest rates begin to rise in the next few years.

The critical benefit in a 412(i) plan is how much income an individual can shelter from taxes. It’s the tax leverage that makes these plans superior to other types of plans. Another added benefit is that the life insurance policies than can be purchased in the plan are paid for with pre-tax contributions free death benefits to the beneficiaries on the pure death benefit above cash value. Still another advantage: A waiver of premium disability rider can be incorporated into the life policy, purchased with the plan to make this a self-completing plan if a disability occurs. How many qualified plans have that option?

Area venture capital firms look forward to another record year
Established technology funds continue to thrive as new funds emerge to seed promising start-ups

Venture capitalists are working up an encore for their phenomenal 1999 performance. And so far, prospects for another blockbuster year look pretty good for Greater Philadelphia’s leading venture funds.

Certainly, nationally, venture investing continues to increase. Venture-backed investments hit a record $17.22 billion in a first quarter 2000, according to PricewaterhouseCoopers’ Money Tree Survey. That’s about 18 percent higher than the previous quarterly record of $14.68 billion, set in the fourth quarter 1999. And it’s more than four times higher than the $4.31 billion invested in first quarter 1999. The bulk of investments are in technology, with technology investments accounting for $34.3 billion in venture capital, more than the total amount invested in the preceding 11 years.

Wayne-based TL Ventures has played a leading role in this investing. Indeed, New York-based Technologic Partners included TL Ventures in its widely watched list of Top 10 Venture Capital Firms. With now-famous cofounders Pete Musser and Bob Keith, TL Ventures is something of a “granddaddy” of venture investing. Many new venture capital firms in the region are trying to imitate TL’s success.

Among the latest is the Eastern Technology Fund, headed by local investors Ian Berg, Wayne Kimmel and Rob McCord. It provides capital for seed-stage Internet and technology companies, and serves as a feeder for Safeguard Scientifics and PA Early Stage funds.

Predictably, plenty of start-ups are hungry for VC cash. The National Federation of Independent Businesses says its small- business optimism index, a measure of perceived growth prospects, keeps surging. And anecdotal evidence suggests a record number of entrepreneurs seeking venture investments. But the small business explosion also is being tempered by venture capitalists’ increasingly strong focus on profitability. Companies that bring goods and services to market quickly, then generate profits, will attract the greatest attention from VCs.

According to TL Ventures Managing Director Mark DeNino, “The market is a lot more selective today and that’s not likely to change anytime soon.”

History begins with Pete
Once upon a time, those who profited by aggregating money from a variety of investors — and creating a pool of capital to help promising businesses grow — had no clearly identified “profession” as “venture capitalists.” What is now called venture capital was then known simply as “table stakes.” Today, it is a well-accepted tenet of business that venture capitalism drives much of the New Economy. And one of the early leaders who helped make venture capital an economic force is Warren V. ‘Pete’ Musser, chairman of Safeguard Scientifics Inc. of Wayne.

“Anyone who reviews the history of the modern venture capital industry should make note of Pete as one true inventor of the field,” says Rob McCord, a venture capitalist and President of the Eastern Technology Council.

McCord says Musser “used incredible instincts, charisma, and a willingness to deviate from what were then standard practices.” Musser created a new type of publicly traded company — Safeguard — that allows investors of all sizes and types to benefit from venture investing. “Pete made many of the nation’s earliest and most profitable venture investments, and he helped popularize the concepts of venture investing and of developing publicly traded companies — like Wayne’s famously successful Internet Capital Group — that provide venture capital.

Now venture capitalism is one of the nation’s leading asset categories. Last year, according to one study, the U.S. capital pool represented 1.49 percent of the country’s gross domestic product. Moreover, industry research group Venture Economics reports that the average VC-backed company received a staggering $15 million in capital during first-quarter financing rounds, almost twice that of the same period in the previous year.

Lots of local buzz
No wonder, then, that start-ups and investors alike are excited about the emergence of new vehicles like the Eastern Technology Fund (ETF). Headed by managing directors Kimmel and Berg, it opened in February and expects to invest up to $20 million in more than 10 companies during the next few months.

In addition to strong alliances with Safeguard and PA Early Stage Partners, the fund has ties to the Technology Council, Ben Franklin Technology Partners of Southeastern Pennsylvania, and Omicron, a premier IT consulting firm.

Initial recipients of ETF investments are EZ Prints, the leading photofinisher for digital imaging; MarketMembers, which enables payroll deduction for common purchases; Ajunto, specializing in automation of e-commerce bidding for technology projects; and EnsuredMail, a secured electronic communications business.

The new fund has generated a lot of local buzz, with complimentary articles in Philadelphia and Philly Tech magazines, the Philadelphia Business Journal, and the Philadelphia Daily News.

Dozens of other venture capitalists also garner plenty of positive ink from the regional press. McCord points to John Martinson at New Jersey’s Edison Venture Fund, Frederick Beste III at Mid-Atlantic Venture Funds, and Mike Bolton, CEO of Pennsylvania Early Stage Partners, as well as Musser, Keith, DeNino, and the other founders and directors of TL Ventures as the heads of “large pools of venture capital that are attracting the best and the brightest in the American business world.”

Proximity counts
TL Ventures certainly ranks among the biggest, with about $750 million under management in five different funds. Like the high- profile technology companies it supports financially, TL Ventures is a bell-weather of sustained success in venture capital investing. All five TL funds rank in the top industry performance quartile, according to Venture Economics.

In addition to its headquarters on the Safeguard campus in Wayne, the firm also has offices in Austin, Tex., Los Angeles and Phoenix, and in May opened a fifth office in Dallas.

“The best way to do early stage investing is to be in close proximity to the companies you fund, so you can assist them as they grow,” explains TL Ventures’ DeNino. As an increasing number of investment opportunities open in various cities, TL maintains a presence there as well.

In addition, TL has taken what DeNino considers an industry- leading step by hosting a national series of interactive workshops for entrepreneurs, called Start Here. The hands-on sessions help promising Internet business candidates with business plan development, legal structure, financial management and fund-raising. The first workshop, held last October, won such rave reviews that three others were scheduled this year. Additionally, last year, TL hired Dr. Andrew Morozov to provide research and assistance to its portfolio companies.

Industry analysts say the highly personal, one-to-one relationship between the venture capitalist and the people running companies in which they invest has always been a VC’s key to survival in a turbulent business world. Many fund directors believe daily conversations with company principals are a must.

Unbridled enthusiasm
Observers agree the recent volatility of the stock market, and a relative dearth of initial public offerings, has cooled public interest in venture capital. But as the PricewaterhouseCoopers statistics show, there’s still tremendous enthusiasm and investment flowing from regional venture funds.

There is also, however, the recognition that investors are interested primarily in results; that is, businesses which have a sustainable ability to earn profits (not just “gain mindshare”). Savvy VCs search for companies that have the potential to outlast — not merely outspend — their competitors. Reuters News Service recently reported that winners of VC backing in this spring’s crop of business plan competitions were companies that demonstrated they could turn a profit no matter what happened on Wall Street.

Sound investments, sound performance. Sounds like the venture capitalists’ strategy to make 2000 another phenomenal year.