Tax Effective Strategies For RETIREMENT PHASE 2

In the Phase one report I discussed why only focusing on the accumulation stage of retirement could be a big mistake.  I emphasized the need for tax diversification in retirement to create the largest after-tax spendable dollar to help maintain your lifestyle when you retire.   

I have seen where people have allocated  their investments in categories relating to the type of tax structure the investment has, and then positioning the category to a timing of when to start taking the withdrawals from the category.  Here are the categories:  

Type of Category Contributions Type of Growth Distribution 
Equities After Tax Tax Deferred Growth Taxable 
Taxable Income After Tax Taxable Growth Taxable 
Tax Free Income After Tax Tax Deferred Tax Free 
Tax Qualified Pre Tax Tax Deferred Fully Taxable 

One method of distribution would be to defer the withdrawal from accounts that are tax deferrable, to grow the value for as long as possible.  As you can see in the chart above, most of the accounts are tax deferred.  However equities, if they are individual stock, may be tax deferred when outside a 401k or IRA, only to be taxed when they are sold.  They may have taxable dividends yearly which would be taxable.  Equities could also be personally purchased mutual funds which are taxable, and in many cases are not the type of account where you can control the timing of the tax exposure.   

One strategy would be to use the taxable income plans first to give the other plans the opportunity to grow through tax-deferment.   Or, we have seen where clients pull out their taxable income from the investments and supplement the balance with tax-free income plans from life insurance or the Roth IRA.   

Other Distribution Methods 

One might consider taking the taxable income category first since the income is taxable.  The 2nd category may be the qualified plan money since that is 100% taxable. The 3rd category may be the equities which are taxed less than then category 1, 2, and are taxed on a capital gain basis. The last category would be tax-free because, the assets can grow tax-deferred over a longer period, and then give off a tax-free income, normally when more income is needed (purchase power and time), and all income would be tax-free.   

Sometimes you need to withdraw income from two or more categories for reasons.  For example, let’s say you are now receiving social security, but you are also receiving taxable income from your mutual funds, but you don’t want to create more taxable income which may disqualify you from some potential benefit.  Or by receiving more taxable income, your social security tax liability will jump from 50% to 85%.   

A consideration under that situation would be to withdraw tax-free income to support the needed income without causing an increase in taxes.  Another need may be to qualify for housing benefits like freezing property assessments.  Tax-free income may be the only way to qualify. 

Qualified plans such as 401k, 403b and IRAs, are the most heavily taxed.     Most people deposit their retirement savings into company plans since they are readily available through their employer.  Very rarely are employees educated as to the tax exposure of the account when they retire, and many are surprised at the taxes they have to pay on the withdrawals.  

In my planning, I use quadrants, I call my system, the “Asset Cycle Portfolio” and make the qualified retirement plan and IRAs the main generator of income.   

I suggest to our clients that they  defer the tax- free income plans, but I do let our clients know that the plans are a great place to grab money for the  support of their larger purchases such as cars, second homes, and other items.   

By using the tax-free life insurance plans, or Roth plans, they avoid paying tax today, and can defer the other accounts.  I like the idea of the “family bank”, using the life insurance, as you can withdraw the money tax-free, and then replace the funds.  I find this a great vehicle with great flexibility for life’s changes.   

It is not uncommon for our clients to finance their new cars using tax-free cash value and pay the loan back at an assumed low rate which they set.  By repaying the loan just like they would if it were a bank, they create the ability to reloan in the future the same money.   

For example, I have a client who purchased their high-end vehicle at the end of the lease by loaning his consulting firm the money to buy out the car.  His firm now has to pay him back over five years at 3%.  He will make about $3,000 in interest earnings, plus his company can take the tax-deduction on the interest of the loan paid to him. 

The big picture 

It’s more important to invest in different categories of assets to have the ability to develop a tax wise strategy when you retire, as opposed to a one demension investment strategy.  By doing so, you can take advantage of tax laws, eliminate unnecessary taxes, and create family banks with effective tax leveraging.   

For more informtion on how to use Tax-Free Life Insurance, request my FREE WHITE PAPER, “Wealth Without Taxes”  

Planning For Retirement Using Investment And Income Tax Strategies (Part 1)

Planning for retirement and accumulating money for that future event is important for many people.  Their concern is to make sure they have enough capital to turn into cash and use as an income payment.  Another consideration is to make sure they don’t outlive their income, as their retirement could last longer than their working career.  

Many retirees will require a substantial amount of capital to provide the income needed to maintain their retirement lifestyle.   Most of the capital is focused on retirement programs, such as 401k/403b, IRAs, and other company sponsored plans.  

The focus is on saving and investing during the accumulation stage, picking investments that compliment what they think will create the capital needed at their target retirement date.  Because of this mindset I find that many people are putting their assets in one investment basket strategy.   By only thinking about an accumulation strategy, they are missing the mark on “net spendable income”, the true driver of their standard of living. They also need to also consider tax diversification strategy in order to accomplish the desired result.  

When people “cash out” at retirement for income, they are surprised to hear their qualified company plan is taxed at 100% of every dollar withdrawn, and that they are forced to take the money (through Required Minimum Distribution). They received a tax deduction on their contribution, which is a very small part of the total retirement pie.  Taxes are the single most expensive part of your retirement, and the component that is planed for the least. 

When consulting with our clients, we suggest they plan the two strategies in conjunction with each other.

  1. The accumulation of assets through investment or “The What”. Such as funds or accounts they wish to invest in.   
  2. The tax ramification of the investments– this is the “The Where”.  Such as IRA, 401, ANNUITY, LIFE INSURANCE – OR THE TAX RAMIFICATION, and the tax effects of each of them. 

There are two risks, investment risk, and tax risk which will erode your retirement nest egg.  

As you plan your retirement and investment you should think about the following: :

a. Diversification of the investments, this is called asset allocation. The purpose of this is to avoid as much risk as possible, while attempting to gain a consistent rate of return. 

b. Income tax diversification:  this is the “where” you have your funds and how will they be taxed when they are turned into cash. 

Taxes are unavoidable and income tax rates change. The assumption is they will be higher than now because Uncle Sam is always looking for more revenue, and normally the higher income earners foot the bill. 

With some of the products of today, you can minimize taxes, and in situations eliminate them altogether. 

When people invest in high taxable investments they have  no options when they distribute the funds to provide an income, they end up paying much more in taxes than if they had a strategy. 

 Part of our strategy is to have our clients recognize the consequences of putting all their assets in “one basket” for income purposes. They need the knowledge of how an investment can be “tax wise”, allowing them to blend their strategies for a lower net tax result.  

An example:  Sam grows his 401k to $600,000.  He can take income from the 401k of $44,149 a year for 20 years, assuming 4% ROI. The tax rate is 33% (state and Federal) as he has a pension and rental income, and his wife has a payout.  By having all of his assets in a taxable account, he will pay $14,569, for a net of $29,579. 

However, if he did some planning, he could have deposited money in a more efficient tax account where the payout would be tax free.  Let us say Sam invested enough money to provide $29,579 in his 401K AND he put the extra in his specially designed 7702 life insurance policy which gave him $14,569 tax free income.  Sam would only pay the taxes on the $29,579 or $9761, $4807 less in taxes.

Observation: 

Because most of the money was in a qualified plan (401k), Sam didn’t have the option of creating tax-free income. He could have converted some of the money to a Roth, however, he would have had a tax liability.  

Tax-strategy planning: is most important to retirees who will have to replace their income in the future. Diversification of retirement assets gives the retiree the option of deciding when the best time to sell, exchange, liquidate or annuitize asset classes.  

Reasons why income tax diversification is important

  1. Retirement can last a long time- in some cases longer than you have worked
  2. Limited working ability 
  3. Investments fluctuate in value
  4. The law changes over time- consequently so do tax rates

Income taxes have the greatest impact on your income, so it’s not as important as to the value of the asset as much as the tax structure of the payout of the asset.  

A cash rich life insurance policy may not grow as great as a mutual fund given the same amount of contribution over time.  However, when income is taken from the policy, it is tax-free.  The mutual fund withdrawal is taxed in some form, either partially, or 100%, depending on the where it was invested (IRA or personal holdings). Consequently, you don’t need as much value in the life insurance to give more tax-free income then the after-tax income from the investment.  

There are five ways to purchase retirement funds

  1. Personally
  2. Roth IRA Individually or through 401k Roth
  3. IRA – tax deduction
  4. Investment in a sub-account inside a variable annuity
  5. Life insurance variable, indexed or permanent

Some types of investment can be tax differently depending on where you purchased them. Life insurance and Roth accounts can create tax-free withdrawals.  

An IRA is 100% taxed upon withdrawal, the same as a qualified pension plan, 401k, 403b. 

Personal investments are partially tax-free(basis), while the other parts of the investment can be ordinary taxes, or capital gain. 

There are also Tax Elements to consider.  

  • Tax deductible contributions: like IRA, 401K/403B
  • Deferment of taxation such as qualified plans, IRA, Roth’s, life insurance, annuities
  • Non-Tax deductible, deferred taxation, and tax-free payouts, like life insurance and Roth IRAS

So it is important to understand “where” you are putting your retirement money, when considering investment and tax strategies. 

Phase 2.  Will discuss the retirement strategy of payout…. 

Request your FREE SPECIAL WHITE PAPER CALLED; Wealth Without Taxes,

Submit the form and we will send you the informative white paper explaining how to set up a tax-free income using your business, with little tax exposure. This is a plan for business owners!  

Critical Step Needed To Create An Exit Strategy! Part 1 

Some business owners think that selling their business is a matter of getting an appraisal and putting the business on the market hoping for a good offer.

Many business owners that I have worked with initially assumed they knew the value of their business and what they could sell it for.

Through our education process they realized there is much more to selling their business, then just the establishing a value and then going to market.     One of those factors or variables is whether the business owner needs the business value for their future retirement, most do!

Helping the owner figure out what they need for retirement is critical in establishing what they need to sell their business for, and what action is needed to increase the future value of the business (Value Drivers).  In this article I will cover two of the seven steps that  are the most critical when planning a future exit from the business.

Whether the sale is one year or ten years from now, these are the steps needed to sell  a business.

  1. Must identify the Exit Objectives (why, when, and in some cases who) 
  2. Identify Personal and business financial resources; (this is part of the future financial security of the business owner and their family).  
  3. Maximize and Protect Business Value
  4. Ownership Transfer to Third Parties
  5. Ownership Transfers to Insiders
  6. Business Continuity
  7. Personal Wealth and Estate planning

In this post I will cover steps 1-3, and cover steps 4-7 in the June issue.  

In comprehensive Exit planning, (when you break the process down it looks like this):

Your Exit Objectives

  • Building and preserving business value
  • Selling your company to a third party
  • Transferring your ownership to insiders

Your Business and Personal Financial Resources

  • Business Continuity
  • Personal wealth and estate planning

Owner’s goals and aspirations are

  • Financial Need
  • Overall Goals
  • Value based goals
  • Defining the owner’s goals and aspirations shows the client’s wants and needs and identifies what is  important to the business owner. By spending time collecting this information from the business owner we establish a strong relationship, while differentiating you, and allowing you to be the quarterback of the plan.

Accurate information from the owner is critical to planning.      Calculating what the GAP of resources the owner needs to have in order to supply their future retirement income is critical.  It is here where the measurement of their resources helps to decide what they need to sell their business for, to help fund the gap.    Continue reading “Critical Step Needed To Create An Exit Strategy! Part 1 “

Case Study#5 Using Corporate Dollars To Keep Wealth Out Of The Business But In Your Pocket

This is the case of Joey Bag of Donuts and his pursuit of keeping wealth outside of his business.  You see, over the years working with Joey Bag of Donuts we told him that leaving too much of his wealth in the business can be problematic, especially when the time came when he needed to exit his business.  He heard me tell him many times, that someday he will leave his business by either a death, disability, or retirement, and taking the wealth with you when you need it the most, can be a problem, if you don’t have the right exit strategy.

There are many reasons wealth gets lost in a business when it is sold.  It can range from bad planning to bad luck, but Joey Bag of Donuts always remembered to keep as much of his personal wealth outside of the business as possible.  By the way this is why he purchased his company building and put it in a separate LLC.  Joey Bag of Donuts also believes in putting as much of his income to the company pension plan, again, outside of the business.

We also taught him to have his company support whatever it can legally towards his personal lifestyle.  For example, his cars, gas, some entertainment, health insurance, retirement, and other things are paid for through company.

Joey Bag of Donuts wanted to put more money away for himself and his family’s future, but didn’t want to use his own funds, so why not have the company support more retirement contributions?

We already had a profit-sharing plan, and he was sharing company contributions with his employees.

We decided that a non-regulated plan was the best way to go, so we developed a plan for only him.  The plan is a combination of two concepts.  We call this the CEEP PLAN (CORPORATE EXECUTIVE EQUITY PLAN).

The plan is a discriminatory plan, so Joey Bag of Donuts can pick himself or anyone else he wants, unlike a profit sharing or 401k plan, which is a regulated plan.

THE PLAN:  As you can see, the company made all the contributions, and took the deductions for them.  Joey Bag of Donuts was the sole participant of the plan. His cost was “0” out of pocket and he ends up with almost $800,000 of cash at retirement.  He also could turn the cash into a tax-free income stream.  In this case it was $67,500 tax-free income. The stream of income is worth more than $1,215,000.  Along with that he has a death benefit of $2,300,000 payable to his family tax-free.

THE BOTTOM LINE:  Joey Bag of Donuts gets retirement income using corporate funds.  All the contributions can be applied to just his account.  He also has the use of the account before retirement, like a  “family bank”, along with the ability to withdraw funds tax-free.[1]  There would be no 10% penalty if withdrawn before 59 ½.  Continue reading “Case Study#5 Using Corporate Dollars To Keep Wealth Out Of The Business But In Your Pocket”

The Major Reason Why Business Owners Don’t Plan For Maximizing Their Business’ Financial Potential Is Now Eliminated!

Many business owners spend the majority of their time running their businesses and inadvertently end up neglecting some of the more important aspects of their business. This is the time where all the details of the success of your business are planned. We call this “working ON your business”.

Business owners can be vulnerable to financial mistakes because of many factors.

One of the key details of a business owner is what happens to their business in the following scenarios:

  1. What happens if I die?
  2. What happens if I become ill, or have a long-term disability?
  3. What happens if I lost my key person, or my key group of employees?
  4. What happens if I can’t control cash flow, or just don’t want to run the business any longer?

Unfortunately, many business owners don’t spend the time working on their business for many reasons.  Many owners think it’s expensive, complicated and very time consuming.

The truth is that by not working on their business, should any of the above scenarios occur, the consequences would be much more expensive, time consuming and potentially devastating.

In our planning practice, we estimate the average time to create a business and estate financial plans for a business owner, is five to ten hours, not including time with attorneys and accountants who are a part of the team.

How does our process work?

Our system is built around planning with the least amount of time needed for the business owner’s time.  To do this we use technology in communication such as phone conferences, video conferences, and audio and video productions to explain our client’s situation.  This allows the business owner to eliminate using work hours for this project.  We can do this technologically with clarity and brevity.  Our plan is focused on brevity for the business owner.

Our Process: 

  1. Viewpoint Meeting: Define what are some of the areas of concern using our Viewpoint System.  This is a 30 minutes conversation.  Our business owners need about ten minutes to prepare using this aid.
  2. “The Selection Meeting”. Once we define the areas of concern, we dig deeper with a 45-minute Selection Meeting. This is where we discuss all of the possible areas where the client may have problems and concerns.
  3. “The Planning Stage” is the longest meeting. This is about 1½ hours.  Prior to the meeting, we send our client material which they can review and prepare on their own time.  This takes them about 20-30 minutes to complete.
  4. The Discovery Meeting is about one hour where we bring together our findings based on their personal situation and discuss which issues and direction of implementation the client may wish to go. Again, our client receives the information to review prior to our Discovery Meeting[i].
  5. Implementation Session: This is where we start implementation needed to solve the issues.  This is the time when all of the client’s advisors work together to get the planning completed.  For example, our findings are discussed with the professional team and look for their advice and suggestions.    Also, this process brings everyone on the team up to date on the business owners’ situation.  This process breeds new ideas and strategies (earlier in the process, I would have been in touch with these advisors between the Discovery and Implementation Meeting). This may be the first time the client has had all of their advisors working together and sharing knowledge about the business owner! 
  6. Semi-Annual or Annual Review:  This is where we move on to the next area of concern; One concern at a time (in some cases, there may be overlapping of concerns and they can be bundled in the planning).  If there are no additional concerns, we review what has been implemented. This is an automatic process, so we are always adjusting as the business situation changes.

For business owners who realize that they need work  on their business, our process can maximize their business’ potential profit, organize them in a timely fashion, and fine-tune them in the future, so they can maximize their “business potential value” when they exit from their business.

[i] We plan for this time, but do not limit this session to a time schedule.

Good Luck You Are Now In Business! Now What?

Chances are that the moment you started your company you felt the need to be in charge of everything (the control thing).  Tasks such as ordering stationary, trips to Staples, talking to the utility company, dictating messages and a sundry of other things. You did pretty much everything including the bookkeeping, sweeping the floors and taking out the garbage. 

 You were proud of your new business and wanted to make sure it did well from the very start and in in every aspect of your business. Even if it meant you had to work 80 hours a week to keep it going to be successful.   

 Then you started to make more money, enough to hire employees to help you grow the business.  As you moved forward so did your business commitments.    Your mindset however, is control, just like when you started the business.   A natural reaction since you started and created your business, the tendency is to protect it, this is your baby! 

THE NEEDED CHANGE IN MINDSET! 

The problem comes when you have to change your mindset as an entrepreneur. When you started your business, you had a talent and believed that your talent could make you profit and grow your business. However, as your business and commitment to the business grows, there needs to be a new way of thinking on how you should run the business.  

 For example; I have a brother who is a great mechanic.   If he were to open his business, he would be the best mechanic you could find.  His work would be impeccable, and everyone would enjoy working with him.  However, the minute my brother had to start thinking strategically about how to lessen his working hours, grow new markets, start a branding campaign, hire people to do some of his tasks, he would become very stressed and would definitely lose interest in running his business.  He is a great mechanic but didn’t think about the other parts of running a business.  All he ever wanted was a place to go paycheckand a position. Little did he realize that it would take more than being a good mechanic to run a business.   He didn’t realize that some of the things he liked to do would have to take a back seat or be delegated to someone else, so he could focus on the details that will allow him to grow his business.    

Continue reading “Good Luck You Are Now In Business! Now What?”

Shift Corporate Income For Your Personal Retirement! 

 If you own a business, using a split dollar life insurance plan can help you shift business income to you on a tax effective basis, without involving other employees!

 Split dollar life insurance refers to the concept of two or more parties splitting the benefits and costs of a life insurance policy, such as the premium, death benefit and cash value.   

The most common type of split dollar life arrangement involves an employer and the employee or owners, with one part owning the policy, one or both parties’ contribution to the annual premium, but both parties having a vested interest in the policy benefits.   

Split dollar plans are inexpensive and easy to administer as an executive benefit arrangement.   

Here is how it works:  

One party establishes a cash value life insurance contract under the ownership of the key executive.   

The employer receives a “collateral assignment” against the policy, entitling the corporation  to receive the lesser of the policy cash value or the outstanding loan balance.   The loan is based on the premiums contributed by the company.   The same assignment entitles the employer to a portion of the policy death benefit, equal to the outstanding loan balance.   

 The key executive pays the taxes each year on the foregone interest on the loan from the corporation to pay the premium.   

At some point in the future, the split dollar arrangement terminates when the employer’s loan is repaid (typically from the policies cash value), leaving the executive “free and clear” ownership of the accumulated gain in the life insurance policy.   

 The executive can access the accumulated gains in the policy by borrowing against it, which will typically allow for tax-free access to the values.  The policy loan is repaid to the insurance company at the death of the executive, and any residual death benefit is paid to the executives’ named beneficiaries.  

Split dollar is an easier benefit to implement than deferred compensation, and less expensive for the employer.   

 Advantages:   

  • Easy account entries 
  • Recovery of the cost for the employer 
  • Performance objectives to trigger the funding for employer 
  • Very little if any impact on company balance sheet 
  • A “golden handcuffs” for the employer and ability to set restrictions when cash value can be accessed  

 Today’s newer types of life insurance policies enhance the benefits of a split dollar plan  Continue reading “Shift Corporate Income For Your Personal Retirement! “

Business Valuation After The 2017 Tax Cut And Jobs Act

Because of the Tax Cut and Job Acts of 2017, the marginal rates are lower.  The impact of the recent tax cut is very straight forward.   Lowering the rate, means a higher after-tax cash flow which translates into higher value for businesses.

Business owners know their business better than anyone.  That being said, you would also assume they would know the value of the businesses? Not so fast!

Knowing your business and knowing what you think it is worth in reality can be two separate issues.  If it were that simple, appraisers would not be needed, but they are, and they play very key role.  They arrive at a fair market value after taking many facts into consideration.

Valuations; “The Walk Way Number

The “country club” concept of a business owner having a number in his/her head as to what they would take, if offered, offers some interesting conversations during happy hour!

Over the years I have spoken to business owners, and periodically I have been told that the owner has a figure in their head, and if they were offered that figure for their business, they would take it!  They seem to know their business better than anyone, so it is reasonable to believe they have a handle on the value of their company.   In more cases than not, that figure would allow the owner to go and do what they want in life as it would give them the capital needed, and the can walk away from the business.

However, there are some different sides to this concept!   A more logical way of knowing the business value!

Continue reading “Business Valuation After The 2017 Tax Cut And Jobs Act”

Your Exit From Your Company!

I read somewhere that over the next number of years, at least one in every four small businesses will be sued or threatened with a lawsuit.  The odds are great that it will come from within the company.   

Will your death, disability, or withdrawal cause a dispute?  In many cases it can come from not having communicated the exit or transition plan for the company.    

 Your Corporate Board of Directors  

 The Board of directors in your company is crucial to the short and long-term success of the company.  The board helps in the avoidance and resolution of disputes.  The board can help direct the company’s planning, officer selection and the compensation.  The board can help in dispute avoidance, dispute resolution and overall corporate management.   

Disputes, can come from compensation agreements, benefits, health co-pays, benefits paid.  These are many other ares which a dispute can occur.  The hope is that there is a board of directors to help with the resolution.   

 When the owner dies, becomes disabled or just wants out of their business, and there is no business continuation or a buy and sell, the risk of a dispute rises.  A buy and sell agreement will establish the rules in the event a trigger that sets off a change within the business.  Remaining partners will need to know what the value of the company stock will be sold for.  The surviving family will need to know what the value of the business is and what the family expects to do with the company values.  Without a solid written plan, there are unanswered questions and confusion.  Continue reading “Your Exit From Your Company!”

Creating Cash Flow In Your Business

Selling your business to a key employee, or a group of employees.

Assuming that all of the purchase price is to come from the key employee (s), you can help the purchase, by (a) using a stock dividend distribution, or (b) bonus of money to the employ, such as a bonus executive program.  (See Restricted bonus agreement). 

It is important that the company have consistent cash flow, (discretionary cash flow;) to use for this purpose.  (This is the cash generated by the company which is not needed to run the operations, for debt service or capitalization of the business).

Planning for the sale of the stock to insiders, and cash flow; 

It is important to have a accurate idea of the yearly cash flow.  For example, if the discretionary cash flow is $1 million a year. You might commit 10% of the company, or $100,000 a year to help pay for stock.  Continue reading “Creating Cash Flow In Your Business”