A true tale of tax-saving

How to create a comprehensive multi-disciplinary approach to planning


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This is a true story of tax-savings thanks to creative planning with some little known techniques. Some of the names have been changed for all the usual reasons.

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-40s, 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!”

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 creating 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. So Max decided that he needed life insurance as a safety net for his family.

But life insurance premiums have to be paid with after-tax dollars. That just wouldn’t do, given Max’s 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.

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 percent investment return on those contributions.

He’ll also have to contribute for his employees – $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.

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. 

While some may question putting the policy in the retirement plan, 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, thanks to the additional longer-term tax-savings strategy built into the plan. 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 – direct dollar-for-dollar swap.

How? 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. In short, two tax-deferred accounts would have been created where there had been just one.

And Max can access that cash value 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. 

Charles “Chuck” Baldwin, co-founder and principal of Bedford-based The Baldwin & Clarke Companies and president of Baldwin & Clarke Advisory Services Inc., can be reached at chuckbaldwin@baldwinclarke.com.

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