Deferred Comp Help

[Powder]

Hello,
Can someone help me out with this situation?

I have a client (Dr.) who hates to pay taxes. Would having him set up a deferred comp plan help defer the current year taxes?

I was thinking about using a life insurance policy inside the plan. My understanding is that as the owner of the business he'd be able to put as much pre-tax money into this policy as he wants without ERISA restrictions. He wouldn't pay until he takes it out similar to a 401(k). Is this true?

If it helps, I'm also securities licensed so if you have any other ideas I'd appreciate it.

Thanks!

 

[Mr. Bill]

In all seriousness, if you're securities-licensed, you need to ask your b/d for information and go with their "flow". It wouldn't matter what anyone else says, if you go outside your b/d's desires, it's, well....good luck.

 

[Powder]

I talked to my b/d already and they said as long as it's an insurance product inside the plan and not a security they don't care what I do.

 

[LGilmore]

Does he have employees? A little more detail about how the business is set up.

You are talking about using a qualified plan. ERISA applies to the plan, not the product inside the plan.

What are you thinking of using? be specific.

 

[scagnt83]

Hello,
Can someone help me out with this situation?

I have a client (Dr.) who hates to pay taxes. Would having him set up a deferred comp plan help defer the current year taxes?

I was thinking about using a life insurance policy inside the plan. My understanding is that as the owner of the business he'd be able to put as much pre-tax money into this policy as he wants without ERISA restrictions. He wouldn't pay until he takes it out similar to a 401(k). Is this true?

If it helps, I'm also securities licensed so if you have any other ideas I'd appreciate it.

Thanks!

It could. It depends how its set up through the business and on the businesses structure/tax status of the business.

Usually yes. Either him, the business, or both can contribute to the business owned deferred comp policy and it will grow tax deferred, and be taxed as income to the employee when received. There is no limits on contributions and these plans usually avoid any erisa regs. Keep in mind that this is a general statement.

But you should really analyze if this will truly save him money in the long run. And if it is the best way to protect his assets in a highly litigious profession?

Business owned deferred comp plans have their place. But always remember that the CV in the plan is an asset within the business, and is not creditor protected like an individually owned policy can be.
An individually owned policy paid with after tax dollars; grows tax deferred, can be accessed on a tax free basis, is usually protected from lawsuits and creditors, and is liquid for the individual as opposed to the business.
A personally owned policy is a great asset for a doctor who has to take extra precaution from claims against his business or personal assets.

Chances are your doctor is around a 40% income tax rate with combined state and federal taxes.
Ask him these questions:
-Does he truly plan to live on less per year in retirement (meaning a good bit lower tax bracket, making tax deferral advantageous)
-Does he honestly believe that taxes will be lower in future, years considering that both the president and congress have stated numerous times that taxes in his income bracket will be going up?
-Does he like the idea of these assets having extra protection against lawsuits and creditors?
-Does he like the idea of being able to have most of these assets accessible to him on a liquid/tax free basis no matter what his age or situation is?
Chances are his answer will be yes to all of the above.

The 162 bonus scenario works well for doctors who are weary of both taxes and lawsuits. Heres the basics of it:
-The company gives a cash "bonus" to the employee under the stipulation that the employee will use the money for a personal deferred savings plan. *The bonus is a tax deductible expense to the business. But it is taxable to the employee as income. Often the "double bonus" method works well, when the business gives two bonuses, one to cover the policy and the other to cover the taxes so the employee doesnt come out of pocket on them. This way the business has a bigger deduction and its a tax wash for the employee.

-The doctor can then take out a personally owned policy that will be more suited to his individual professional risks. So basically the premiums become tax deductible to the business, and a true tax wash for the doctor on an individual basis. Plus the growth and income taken will all be tax free.

Depending on how much cash flow we are talking about and the structure/needs of the business, a combination of the 162 double bonus and business owned/controlled policies is often the way to go with a doctor/business owner.

Also keep in mind that a Roth 401K (unlike the IRA) has no income restrictions on who can participate. So a Roth 401K, especially with safe harbor, can be a great asset to a high income earner, especially a doctor since these assets are protected from creditors.

If your contracted with Lincoln, John Hancock, or Pac, they all have good corporate benefits departments. Your local wholesaler should be able to help with planning issues if you need it.
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I talked to my b/d already and they said as long as it's an insurance product inside the plan and not a security they don't care what I do.

Thats usually true for most B/Ds. Life insurance is the most advantageous product to use in a non qualified deferred comp situation usually. Company stock is probably the next most widely used.

Securities/financial products of almost any type could serve as the funding of the plan as long as they where risk appropriate to the situation (which is all your b/d would care about).
But it goes back to the tax status, flexibility, and multiple uses of Permanent Insurance as to why it is the most widely used product. You can always use VUL if their risk tolerance is high enough (but im not a huge fan of doing this with a business owned policy)

Remember, a NQDC plan is merely a legal agreement between the business and an employee to pay that employee some amount of money in some shape or fashion at a later date dictated in the agreement. Life insurance is merely the funding inside of this agreement. When your talking about a single business owner, the legal documentation gets a lot more simple though. This is why I love doctors and dentist who have a solo practice!

 

[Powder]

Thanks scagnt83 for the great reply! I really appreciate it. This just confirms I was on the right track. Now I need to sit down with him to see what best fits his situation.

The tough part will be to convince him that paying taxes now may be more beneficial to him than paying taxes in the future. Hopefully he's not short-sighted about it.

If anyone else has other opinions I'd love to hear them!

 

[Full Throttle]

Show him two options: pay the pennance now and pay the pennance later. Explain which option you favor and why, but that it's his money and his choice. Either way, you win and serve what the clients wants to accomplish.

 

[scagnt83]

The tough part will be to convince him that paying taxes now may be more beneficial to him than paying taxes in the future. Hopefully he's not short-sighted about it.

Proposition it to him like this:
With the double bonus he is not paying tax on an individual basis. Its a tax wash for his personal finances/taxes, since the 2nd bonus from the company covers all personal taxes. Plus there is the added bonus of a tax deduction for his company.
So not only does he not pay any income tax on this bonus/income/premiums, but all income from the growth is completely tax free. Thats 3 different forms of tax savings; 2 for his personal finances, and 1 for the business. Plus the added protection of being sheltered from lawsuits...

If he likes business owned/controlled tax deferral too, and there is enough cash flow to fund it. You could layer on a business owned/funded policy that would deffer taxes for him until retirement. This way he takes both approaches to help spread his risk.

Tax deferral can be a good thing, but not always. You hopefully have a lot of gain inside of a deferred comp plan of any kind; by paying taxes now you only pay taxes on the basis, and get the growth tax free. So illustrate it to him as avoiding paying tax on a significant portion of the amount accumulated.
$20K over 10 years at 10% is $350K. Thats $150K in growth; and $150K that he could avoid paying taxes on in the 162 double bonus scenario...


Its usually not that hard of a sell once you show them some simple numbers

 

[BNTRS]

What's that I hear? 412(i)?

 

[scagnt83]

What's that I hear? 412(i)?

412(i) could be a possibility, but it does fall under some erisa regs.
Im not saying they are bad, it certainly could be an option in this case. Im actually a big fan of 412(i) plans when they fit.
But im just pointing that out since the original question mentioned avoiding the erisa regs.