What Was a 412(i) Plan?

A 412(i) plan was a defined-benefit pension plan that was designed for small business owners in the U.S. It was classified as a tax-qualified pension plan, so any amount that the owner contributed to it could immediately be taken as a tax deduction by the company. Guaranteed annuities or a combination of annuities and life insurance were the only things that could fund a 412(i) plan. The 412(i) plan was replaced by the 412(e)(3) plan after Dec. 31, 2007.

Understanding a 412(i) Plan

Notably, 412(i) plans were developed for small business owners who often found it difficult to invest in their company while trying to save for employees’ retirement. The 412(i) plan was unique in that it provided fully guaranteed retirement benefits.

An insurance company had to sponsor the 412(i) plan, and only insurance products like annuities and life insurance policies could fund it. Contributions to it provide the largest tax deduction possible.

An annuity is a financial product that an individual can purchase via a lump-sum payment or installments. The insurance company, in turn, pays the owner a fixed stream of payments at some point in the future. Annuities are primarily used as an income stream for retirees. 

Due to the large premiums that had to be paid into the plan each year, a 412(i) plan was not ideal for all small business owners. The plan tended to benefit small businesses that were more established and profitable.

For example, a startup that had gone through several rounds of funding would have been in a better position to create a 412(i) plan than one that was bootstrapped and/or had angel or seed funding.

These companies also often don’t generate enough free cash flow (FCF) to put away consistently for employees’ retirement. Instead, the founding team members often re-invest any profits or outside funding back into their product or service to generate new sales and make updates to their core offerings.

412(i) Plans and Compliance Issues

In August 2017, the Internal Revenue Service (IRS) identified 412(i) plans as being involved in various types of non-compliance. These also included abusive tax avoidance transaction issues. To help organizations with 412(i) plans come into compliance, the IRS developed the following survey. They asked:

• Do you have a 412(i) plan?
• If so, how do you fund this plan? (i.e., annuities, insurance contracts, or a combination?)
• What is the amount of the death benefit relative to the amount of retirement benefit for each plan participant?
• Have you had a listed transaction under Revenue Ruling 2004-20? If so, have you filed Form 8886, Reportable Transaction Disclosure Statement?
• Finally, who sold the annuities and/or insurance contracts to the sponsor?

A survey of 329 plans yielded the following:

• 185 plans referred for examination
• 139 plans deemed to be “compliance sufficient”
• Three plans under “current examination”
• One plan noted as “compliance verified” (meaning no further contact was necessary)
• One plan labeled as not a 412(i) plan

412(e)(3)

Due to the abuses of the 412(i) plan resulting in tax avoidance schemes, the Internal Revenue Service (IRS) moved the 412(i) provisions to 412(e)(3), effective for plans beginning after Dec. 31, 2007. 412(e)(3) functions similarly to 412(i), except that it is exempt from the minimum funding rule. According to the IRS, the requirements for 412(e)(3) are as follows:

• Plans must be funded exclusively by the purchase of a combination of annuities and life insurance contracts or individual annuities,
• Plan contracts must 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 in the plan (or, in the case of an increase in benefits, commencing at the time such increase becomes effective),
• Benefits provided by the plan are equal to the benefits provided under each contract at normal retirement age under the plan and are guaranteed by an insurance carrier (licensed under the laws of a state to do business with the plan) to the extent premiums have been paid,
• Premiums payable under such contracts for the plan year, and all prior plan years, have been paid before lapse or there is a reinstatement of the policy,
• No rights under such contracts have been subject to a security interest at any time during the plan year, and
• No policy loans are outstanding at any time during the plan year

What Is the Accounts Payable Turnover Ratio?

The accounts payable turnover ratio is a short-term liquidity measure used to quantify the rate at which a company pays off its suppliers. Accounts payable turnover shows how many times a company pays off its accounts payable during a period.

Accounts payable are short-term debt that a company owes to its suppliers and creditors. The accounts payable turnover ratio shows how efficient a company is at paying its suppliers and short-term debts.

The AP Turnover Ratio Formula


$\begin{aligned} &\text{AP Turnover}=\frac{\text{TSP}}{(\text{BAP + EAP})/2}\\ &\textbf{where:}\\ &\text{AP = Accounts payable}\\ &\text{TSP = Total supply purchases}\\ &\text{BAP = Beginning accounts payable}\\ &\text{EAP = Ending accounts payable}\\ \end{aligned}$​AP Turnover=(BAP + EAP)/2TSP​where:AP = Accounts payableTSP = Total supply purchasesBAP = Beginning accounts payableEAP = Ending accounts payable​

Calculating the Accounts Payable Turnover Ratio

Calculate the average accounts payable for the period by adding the accounts payable balance at the beginning of the period from the accounts payable balance at the end of the period.

Divide the result by two to arrive at the average accounts payable. Take total supplier purchases for the period and divide it by the average accounts payable for the period.

Decoding Accounts Payable Turnover Ratio

The accounts payable turnover ratio shows investors how many times per period a company pays its accounts payable. In other words, the ratio measures the speed at which a company pays its suppliers. Accounts payable is listed on the balance sheet under current liabilities.  

Investors can use the accounts payable turnover ratio to determine if a company has enough cash or revenue to meet its short-term obligations. Creditors can use the ratio to measure whether to extend a line of credit to the company.

A Decreasing AP Turnover Ratio

A decreasing turnover ratio indicates that a company is taking longer to pay off its suppliers than in previous periods. The rate at which a company pays its debts could provide an indication of the company’s financial condition. A decreasing ratio could signal that a company is in financial distress. Alternatively, a decreasing ratio could also mean the company has negotiated different payment arrangements with its suppliers.

An Increasing Turnover Ratio

When the turnover ratio is increasing, the company is paying off suppliers at a faster rate than in previous periods. An increasing ratio means the company has plenty of cash available to pay off its short-term debt in a timely manner. As a result, an increasing accounts payable turnover ratio could be an indication that the company managing its debts and cash flow effectively.

However, an increasing ratio over a long period could also indicate the company is not reinvesting back into its business, which could result in a lower growth rate and lower earnings for the company in the long term. Ideally, a company wants to generate enough revenue to pay off its accounts payable quickly, but not so quickly the company misses out on opportunities because they could use that money to invest in other endeavors.

AP Turnover vs. AR Turnover Ratios

The accounts receivable turnover ratio is an accounting measure used to quantify a company’s effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid.

The accounts payable turnover ratio is used to quantify the rate at which a company pays off its suppliers. Accounts payable turnover shows how many times a company pays off its accounts payable during a period.

Accounts receivable turnover shows how quickly a company gets paid by its customers while the accounts payable turnover ratio shows how quickly the company pays its suppliers.

Limitations of AP Turnover Ratio

As with all financial ratios, it’s best to compare the ratio for a company with companies in the same industry. Each sector could have a standard turnover ratio that might be unique to that industry.

A limitation of the ratio could be when a company has a high turnover ratio, which would be considered as a positive development by creditors and investors. If the ratio is so much higher than other companies within the same industry, it could indicate that the company is not investing in its future or using its cash properly.

In other words, a high or low ratio shouldn’t be taken on face value, but instead, lead investors to investigate further as to the reason for the high or low ratio.

Example of the Accounts Payable Turnover Ratio

Company A purchases its materials and inventory from one supplier and for the past year had the following results:

• Total supplier purchases were $100 million for the year.
• Accounts payable was $30 million for the start of the year while accounts payable came in at $50 million at the end of the year.
• The average accounts payable for the entire year is calculated as follows:
• ($30 million + $50 million) / 2 or $40 million
• The accounts payable turnover ratio is calculated as follows:
• $100 million / $40 million equals 2.5 for the year
• Company A paid off their accounts payables 2.5 times during the year.

Assume that during the same year, Company B, a competitor of Company A had the following results for the year:

• Total supplier purchases were $110 million for the year.
• Accounts payable of $15 million for the start of the year and by the end of the year had $20 million.
• The average accounts payable is calculated as follows:
• ($15 million + $20 million) / 2 or $17.50 million
• The accounts payable turnover ratio is calculated as follows:
• $110 million / $17.50 million equals 6.29 for the year
• Company B paid off their accounts payables 6.9 times during the year. Therefore, when compared to Company A, Company B is paying off its suppliers at a faster rate.

What Is the Accumulation Phase?

Accumulation phase has two meanings for investors and those saving for retirement. It refers to the period when an individual is working and planning and ultimately building up the value of their investment through savings. The accumulation phase is then followed by the distribution phase, in which retirees begin accessing and using their funds.

How the Accumulation Phase Works

The accumulation phase is also a specific period when an annuity investor is in the early stages of building up the cash value of the annuity. This building phase is followed by the annuitization phase, where payments are paid out to the annuitant.

The accumulation phase essentially begins when a person starts saving money for retirement and ends when they begin taking distributions. For many people, this starts when they begin their working life and ends when they retire from the work world. It is possible to start saving for retirement even before beginning the work phase of one’s life, such as when someone is a student, but it is not common. Typically, joining the workforce coincides with the start of the accumulation phase.

Importance of the Accumulation Phase

Experts state that the sooner an individual begins the accumulation phase, the better, with the long-term financial difference between beginning to save in one’s 20s vs. in the 30s substantial. Postponing consumption by saving during an accumulation period will most often increase the amount of consumption one will be able to have later. The earlier the accumulation period is in your life, the more advantages you will have, such as compounding interest and protection from business cycles.

In terms of annuities, when a person invests money in an annuity to provide income for retirement, they are at the accumulation period of the annuity’s life span. The more invested during the accumulation phase, the more will be received during the annuitization phase.

Real-World Examples

There are many income streams that an individual can build up during the accumulation phase, starting from when they first enter the workforce, or in some cases, sooner. Here are a few of the more popular options.

• Social Security: This is a contribution automatically deducted from every paycheck you receive.
• 401(k): This is an optional tax-deferred investment that can be made paycheck-to-paycheck, monthly, or yearly provided your employer offers such an option. The amount you can set aside has yearly limits and also depends on your income, age, and marital status.
• IRAs: An Individual Retirement Account can be either pretax or after-tax, depending on which option you choose. The amount you can invest varies year-to-year, as set out by the Internal Revenue Service (IRS), and depends on your income, age, and marital status.
• Investment portfolio: This refers to an investor’s holdings, which can include assets such as stocks, government, and corporate bonds, Treasury bills, real estate investment trusts (REITs), exchange-traded funds (ETFs), mutual funds, and certificates of deposits. Options, derivatives and physical commodities like real estate, land and timber can also be included in the list.
• Deferred payment annuities: These annuities offer tax-deferred growth at a fixed or variable rate of return. They allow individuals to make monthly or lump-sum payments to an insurance company in exchange for guaranteed income down the line, typically 10 years or more.
• Life insurance policies: Some policies can be useful for retirement, such as if an individual pays an after-tax, fixed amount annually that grows based on a particular market index. The policy would need to be the kind that allows the individual to withdraw in retirement the principal and any appreciation from the policy essentially tax-free.

What Is Absolute Return?

Absolute return is the return that an asset achieves over a specified period. This measure looks at the appreciation or depreciation, expressed as a percentage, that an asset, such as a stock or a mutual fund, achieves over a given period.

Absolute return differs from relative return because it is concerned with the return of a particular asset and does not compare it to any other measure or benchmark.

How Absolute Return Works

Absolute return refers to the amount of funds that an investment has earned. Also referred to as the total return, the absolute return measures the gain or loss experienced by an asset or portfolio independent of any benchmark or other standard. Returns can be positive or negative and may be considered uncorrelated to other market activities.

Relative and Absolute Returns

In general, a mutual fund seeks to produce returns that are better than its peers, its fund category, and the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. The success of the asset is often based on a comparison to a chosen benchmark, industry standard, or overall market performance.

As an investment vehicle, an absolute return fund seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds. Absolute return investment strategies include using short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets. Absolute returns are examined separately from any other performance measure, so only gains or losses on the investment are considered.

The History of Absolute Return Funds

Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. In recent years, the absolute return approach to fund investing has become one of the fastest-growing investment products in the world and is more commonly referred to as a hedge fund.

Hedge Funds

A hedge fund is not a specific form of investment; it is an investment structured as a pool and set up as either a limited partnership or limited liability company (LLC). A hedge fund manager raises funds by working with outside investors. The manager uses the funds to invest based on a declared strategy involving only the purchase of long equities, such as common stock.

Hedge funds may specialize in specific areas, such as real estate or patents, and may also engage in private equity activities. While anyone may invest in a hedge fund, participants are traditionally accredited and sophisticated investors.

Example of Absolute Return

As a historical example, the Vanguard 500 Index ETF (VOO) delivered an absolute return of 150.15% over the 10-year period ending Dec. 31, 2017. This differed from its 10-year annualized return of 8.37% over the same period. Further, because the S&P 500 Index had an absolute return of 153.07% over the same period, absolute return differed from the relative return, which was -2.92%.