Maximizing High Net Worth to Fund Retirement Plans for Business Owners
So why would you want to set up an Insured Retirement Plan as a business owner? To dividend out your retained earning subjects you pay taxes at your personal marginal tax rate. Depending upon how much you pay yourself (Salary, Bonuses, Dividends) in any given year can mean that you pay a ton of personal income tax (thanks to Mr Trudeau, that rate is almost 54%). Is there a better way?
What is an Insured Retirement Plan?
Essentially, it’s overfunding a life insurance policy. This could be a Whole Life, Universal Life policy or Hybrid Life policy (combination of whole life and U.L). A portion of the policy goes to fund the life insurance and the balance acts as an investment vehicle (UL) or is a dividend issued by the insurance company (after administration, mortality rate). The nice part about the growth component (cash value) of the policy, it grows tax-free within an insurance policy. Without having to pay taxes on this growth, it’s equivalent to an even greater yield compared to capital gains within a non-registered equities fund. It’s like the equivalent of having very consistent, double-digit growth within an equity fund.
Types of Insured Retirement Plans
An Insured Retirement Plan (or IRP) can take place either personally or from a business. The differences are the potential tax consequences. A personal Insured Retirement Plan uses after-tax dollars whereas an Insured Retirement Plan used by a business owner, comes out of the Retained Earnings of the business. Depending upon the size and profitability of the business, the tax rate paid could be as little as 15%.
What Affects the Size of the Insured Retirement Plan?
The growth of an IRP depends upon:
- the age of the insured (older owner means higher cost of pure net insurance)
- the health of the insured (less healthy individuals means a higher cost of net pure insurance)
- the size of the policy (the larger the life policy means the larger the amount of room to overfund)
- whether you want to plan for a greater death benefit or cash value (taking advantage of features like Extra Deposit Options will allow the cash value to grow more quickly)
- the type of policy (participating whole life insurance offers steady consistent yields year over year, whereas Universal Life policies can have greater volatility due to the investment nature of the policies)
Accessing the Cash Value of an Insured Retirement Plan?
Taking policy loans or cancelling a permanent life policy will trigger a tax consequence because it’s seen as a deemed disposition of the policy. A smarter and frequently used alternative is to use the cash value of the permanent life insurance as collateral and taking a loan, annuity or line of credit through a financial institution against the policy. Because you’re not disposing of the policy, the policy continues to grow. Depending upon the type of permanent life insurance, the leveraged amount of the cash value within the policy can be as much as 95%. Considering a bank will issue a line of credit up to 80% of the equity in your home, the bank deems certain permanent life insurance policy to be a safer investment than your house! You will be required to repay the amount leveraged and any interest charges owing. The bank can get paid at any time or often upon the eventual death of the insured. Upon the death, the bank gets paid whatever it’s owed and the balance of the policy gets paid out to the beneficiaries of the policy. It’s a nice tidy arrangement for all parties involved.
The Best Time to Start an Insured Retirement Plan?
The best time to start an Insured Retirement Plan is as early as possible. The younger you are when you start, the less it will cost you for insurance. Because you will need to medically qualify for an IRP, (it is an Insurance contract after all), the healthier you are, the less the insurance will cost you.
Quick-pay options are available with many IRPs. It’s not inconceivable to have an IRP policy paid off in 10 or 20 years. In this situation, life insurance and the cash value within the policy continues to grow provided you don’t cancel the policy. When the policy is paid off, there’s no good reason why you’d cancel it.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolved from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.