A Tax Tale
We thought we’d have some fun with our Blog this month, so gather ‘round the campfire friends for a Tax Tale that may become the stuff of legend to be repeated around campfires for years to come. (Okay, maybe not.) Your narrator is Chuck Baldwin. “This is a true story of tax savings thanks to creative planning with some little known techniques. Some of names have been changed for all the usual reasons. So break out the marshmallows and lend an ear.“There once was a business owner who was very happy because his business was making lots of money. Let’s call him Max Tax.
In his early-forties, Max saw a bright future for himself, his family and his company. “One day Max confided to a family friend, ‘Dan, I’m paying way too much in taxes. Sure wish I could do something about it.’ “Dan said, ‘Max, you’re in luck. It so happens I know a guy!’ “Well, wouldn’t you know it, that “guy” turned out to be Baldwin & Clarke.
“After a few conversations with Max, it was clear that he had many things that were important to him other than taxes, but his singular focus on building his company had left them unattended. This looked like a job for… no not Superman, but the next best thing, for Max anyway: A comprehensive multi-disciplinary planning approach.
“Thanks to that planning, wills and trusts were put in place; necessary for sure, as Max didn’t even have a will, but of no help with Max’s income tax problem.
“It’s no surprise that Max kind of assumed that the business would take care of his wife and kids if something happened to him. While the business might provide something for his widow and children, it wasn’t yet sustainable without him: he was the business. Max decided that he needed life insurance as a safety net for his family.
“Okay, so Max wanted life insurance, but premiums have to be paid with after tax dollars. That just wouldn’t do, given his concern about taxes. Fortunately, there was a better way
“A combination of two qualified retirement plans were designed for Max’s company: a cash balance pension plan and a new comparability 401(k) plan. Our campfire would be long gone if I got into the technicalities of these plans, so let’s just focus on the results for Max.
“Between the two plans, Max will get annual tax deductible contributions of $155,000. By age 62, Max could build a retirement account of $5,380,000, assuming a 5% investment return on those contributions.
“I see a burning marshmallow waving out there. Question Jack? Or are you trying to save your marshmallow?”
“Won’t he have to contribute for his employees, too?”
“Sure. $38,000 per year with an after tax cost of only $23,200. Bottom line: Max gets the $155,000 annual contribution, provides a benefit for employees and pockets $30,000 in cash that otherwise would have been paid out in taxes!
“Now let’s go back to the life insurance issue. The plan design calls for partially funding the cash balance plan with a 10-pay life insurance policy for Max. Because the policy premium of $50,000 is a part of the plan contribution, it becomes tax deductible! That policy will provide a $1,355,000 death benefit for Mrs. Tax and their children.
“B&C Advisory, using its proprietary strategies for risk management, created a fee based diversified investment portfolio that checked all the boxes from a fiduciary perspective, for the rest of the plan contribution.
“Another question, Jack?”
“Yeah, life insurance cash values grow on a tax deferred basis anyway. By putting the policy in the retirement plan, B&C was putting a tax shelter in a tax shelter. Some people think that’s a bad idea.”
“Max’s CPA liked the whole plan, and saw that the premium deductibility made it a no brainer to have the insurance in the plan. Nonetheless, he raised the same issue. But, he was all smiles when he heard how an additional longer term tax savings strategy built into the plan would turn that negative into a positive.
“Remember. That policy would be fully paid up in 10 years, meaning that no additional premiums would be needed. What an opportunity this creates for Max!
“After 10 years he could take money from a personal taxable investment account and use it to buy the policy for its cash value from the retirement plan; a direct dollar for dollar swap. I see some head scratching and wrinkled brows out there. I get it, but let’s see why Max’s accountant loved the idea.
“The money that was in Max’s taxable account outside of the plan, would now be inside the plan and growing on a tax deferred basis. The life insurance policy that was inside the plan would now be outside of the plan and the cash values would, by definition, grow on a tax-deferred basis, just as Jack said a minute ago. In short, two tax-deferred accounts would have been created where there had been just one!
“Any questions? Yes, Sue?”
“Will that cash value do anything for Max?” “Great question. Sure thing. He can access it at any time. For example he can use it as a ‘bank’, take loans and repay them whenever. The planning in this case showed Max how it could add to his retirement income.
“At age 63, he can take $51,000 a year out of the policy income tax free for 10 years, thereafter he can continue to take the same amount to age 121, but on a taxable basis—and still have $3,150,000 of cash value left in the policy!
“By the way, Max was also shown how to take the money tax-free in all years, but that’s a story for another campfire.
“Well, the marshmallows are gone and the flames reduced to glowing embers, so let’s wrap up our Tax Tale with a quick summary of what multi-disciplinary planning accomplished for Max:
“Who knows, perhaps there’s a campfire story in your future. Please contact us if you would like to learn more about these techniques or, more generally, how Baldwin & Clarke’s multi-disciplinary planning might benefit you. We would love to hear from you.”
Thank you for “listening” to our Tax Tale. The concepts discussed above are complex and the technicalities were omitted from the dialogue out of necessity. The “Tax Tale” discussion of the 10-pay life insurance policy’s possible performance included both guaranteed and non-guaranteed policy elements.
Charles (“Chuck”) Baldwin
Baldwin & Clarke Advisory Services, Inc.
About the author: Chuck is the co-founder and principal of The Baldwin & Clarke Companies and the President of Baldwin & Clarke Advisory Services, Inc. Chuck specializes working with entrepreneurs, individuals, and their families to deliver high touch planning solutions designed to create, preserve and transfer wealth.