[Editor's Note: I occasionally get a guest post that I find interesting but whose author is surprised to find that I won't run it on the blog except as a Pro/Con style post because they already felt they included the “con side” in their original submission. Most of the time, I don't know anyone that could write a really great “con” post, so I end up writing it myself. That often puts me at a disadvantage because I usually know less about the subject than the original author. That's okay though, the point of these posts isn't to “win a debate” but rather to provide a well-rounded, in-depth look at a controversial topic.
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Today's topic is the “Restricted Property Trust” and comes from a submission from insurance agent Jason Mericle of RestrictedProperty.com. I'll let him explain what it is and who might want to look at it. Then I'm going to explain why I think most docs shouldn't bother. Jason and I have no financial relationship.]
Pro – Jason Mericle
Restricted Property Trusts Can Benefit Some Physician Business Owners
Over the past two decades, there have been a few strategies promoted by life insurance agents touting large tax deductions using life insurance as the primary funding vehicle. Many of these plans (412(i), 419a(f)(6), 419(e), and Section 79) eventually came under IRS scrutiny and ultimately became useless or even worse — listed transactions.
The Problem with Business Owned Life Insurance
Most of the abuses occurring under these plans were a direct result of administrators and insurance companies pushing the limits of the Internal Revenue Code (IRC) and life insurance product design. The end result being an epic (and costly) failure for participants. Without going into all the details as to why and how each of these plans was abusive, the main underlying theme of all of them was TAX AVOIDANCE.
The fallout from these abusive plans is that any strategy involving a deduction and life insurance is automatically deemed to be abusive. Does that mean you should throw caution to the wind when you see a plan offering a deduction and life insurance? Absolutely not. Abusive plans still exist in many different forms. It is an unfortunate part of the life insurance industry. Whenever any type of deduction exists somebody will try and figure out a way to push the limits and add life insurance.
For purposes of full disclosure and transparency, I have held an insurance license since 2000 with a focus on life insurance. I have seen the good, bad, and ugly of these plans and product manipulation for nearly 20 years.
In the early 2000s I did “sell” a client a 412(i) plan. However, instead of funding it with life insurance, I chose to recommend funding the entire contribution using a fixed annuity. The result was a positive outcome for the participant and their overall retirement strategy.
Introducing the Restricted Property Trust
Jason Mericle
In 2010, I was introduced to a strategy called a Restricted Property Trust. Due to the history of the industry and the aforementioned abuses, I was skeptical. After completing my own due diligence and understanding of the mechanics it became clear to me it was different than the “other” plans.
The Restricted Property Trust (RPT) is designed for high-income earning business owner physicians and key employees. An RPT provides long-term, tax-favored cash accumulation and cash flow utilizing a conservative whole life insurance policy. Before we get into the details of how the Restricted Property Trust works it is important to note it has a 100-percent successful track record with the IRS, including four national reviews. The IRS has determined it is not a listed transaction because the plan is a mechanism for tax-deferral, not tax avoidance. This is critical.
Is a Restricted Property Trust Right For You?
A Restricted Property Trust can only be established by an S-Corp, C-Corp, Limited Liability Company (LLC), or Limited Partnership. Sole proprietors cannot adopt a Restricted Property Trust, which includes LLCs taxed as a sole proprietorship. Contributions to a Restricted Property Trust are a 100-percent deductible contribution under Internal Revenue Code (IRC) 162 to the business. The participant will typically recognize 30-percent of the total contribution on their individual return in the form of an 83(b) election.
There are two primary factors to consider prior to establishing a Restricted Property Trust.
- First, the minimum annual contribution is $50,000.
- Second, there is a mandatory 5-year funding commitment.
Following completion of the 5-year commitment, the participant has the option to continue funding for an additional 5-years.
A key provision of the Restricted Property Trust is the employer is required to make the annual contribution in accordance with the pre-established funding period. In the event the employer is not able to make the contribution during the funding period, the policy is surrendered to the trust. The proceeds are then distributed to a public charity designated by the participant when the trust is established.
Contributions from the employer to the Restricted Property Trust are used to purchase a whole life insurance policy. Whole life insurance is a low-risk asset class like a certificate of deposit (CDs), money market, or treasuries.
Legitimate Business Need
Since we are using whole life insurance (in order to qualify for the deduction) there must be a reasonable business need for the life insurance coverage. This is most easily understood by recognizing what the economic loss to the business would be if the participant passed away.
For example, let’s assume a physician establishes a Restricted Property Trust for their practice. We review the company's tax return and determine we are comfortable defending a $5 million death benefit. The reason for this is if something happens to the physician, the practice is in big trouble.
The IRS may ask why didn’t do this for your receptionist? If something happens to the receptionist, the physician is going to get a new receptionist. There would not be an economic or financial loss to the practice that would come even close to the loss of the physician.
Because of this, the Restricted Property Trust is fully-selective. Unlike qualified plans, the business can choose who participates provided the company would suffer an economic loss due to the untimely death of the participant. At the end of the day clients generally only care about the deduction 9 times out of 10. They’re not necessarily death benefit motivated. The tax deduction is what motivates them to do it. The life insurance is only along for the ride.
Restricted Property Trust Case Study
Let’s look at a scenario where we have a medical practice with four equal owners varying in age from 42 to 68. Each of the physicians earns approximately $1 million per year, and the medical practice is conservatively valued at $15 million.
One of the physician-owners is introduced to the Restricted Property Trust and is interested in its potential to help them deduct and defer a portion of their income. The physician takes it to their other three partners, and they decide they are not interested in participating. But they agree to allow this physician to establish a plan.
Since the physician is going to owe taxes on 30-percent of the total contribution via an 83(b) election he would need to gross $124,545 to net the $100,000 contribution ($30,000 (taxable amount) divided by (1 less .45 tax rate) plus $70,000). The alternative is to not participate in the RPT and recognize the $124,545 as income resulting in net income of $68,500 ($124,545 time (1 less .45 tax rate)).
Assuming the physician contributes $100,000 for 5-years and extends it for another 5-years he will receive a net deduction of $700,000 over the ten-year period. When the funding period is complete the policy is distributed from the trust to the participant.
When the policy is transferred there will be additional taxes owed. The tax payment is most commonly paid by taking a withdrawal from the policy. The participant is not required to pay this tax from other assets. In some cases, it may make sense to consider doing this, but it is not a requirement. After the policy is transferred and the tax is paid, the death benefit is reduced in order to maximize the tax-deferred growth inside the policy. At this point, the policy owner can access tax-free income from the policy.
Under this example, if the physician elected to access income from the policy at age 66 they would receive $87,229 per year for 20-years based on current assumptions. This results in a tax-free income of $1,744,580 over a 20-year period.
If we compared the $87,229 distribution to a taxable investment earning 8-percent — the taxable investment account would be depleted by the end of year sixteen. Resulting in total income of $1,504,790 over this period.
In addition to the tax-free income created by the Restricted Property Trust, if death were to occur the life insurance policy would pay a death benefit to the named beneficiary. The death benefit is received income tax-free. Once all the income is received from the policy there is still a death benefit of $353,677 in this example. This death benefit will be paid upon the death of the insured in addition to the income already received.
Now, if I told you this was all possible to do, but in order to do so and achieve the exact same results — it would require you use a whole life insurance policy as a funding vehicle. Would this change your mind? The reality is the life insurance policy is a bonus. It is simply along for the ride with the added benefit of providing your beneficiaries a death benefit.
The Restricted Property Trust is not for everyone, but for the right high-income earning physician it can be extremely beneficial.
I agree that whole life insurance is generally not a great investment vehicle. However, when you combine the tax benefits available under the Restricted Property Trust with the policy it can be a tremendously valuable asset. The plan itself has outlasted and flourished during a time when many strategies promising big tax deductions involving life insurance failed. For the right physician, it is worth considering.
Con – The White Coat Investor
A Restricted Property Trust Is a Method to Sell More Whole Life Insurance
A useful rule of thumb that has served decades of investors well is to never take any financial advice from someone who sells insurance and especially somebody who gets a significant percentage of their income from the sale of whole life insurance policies. I have spent countless hours online explaining the way these policies work, the issues with the policies, and especially the issues with the way the policies are sold. I'm not going to repeat all of that here, but someone unfamiliar with whole life insurance will likely find the following links useful:
What You Need to Know About Whole Life Insurance
Inappropriate Whole Life Insurance Policy of the Week
As a brief recap, buying a whole life insurance policy is a lot like getting married. It is either “until death do you part” or it is going to cost you a lot of money to get out. So treat buying a policy with the same amount of due diligence you would put into getting married. Be aware of some of the basic stats about whole life insurance: 80% of those who buy policies later surrender them, 75% of doctors who have purchased policies later regret their decision, commissions on a policy are 50-110% of the first year's premium, and your return on the investment will be negative for 5-15 years and low even if you hold it for decades.
I have written about a business owned life insurance scheme before: Section 79 Plans
So, knowing all that about whole life insurance, does it make sense to buy it if you do so in this particular scheme called a Restricted Property Trust? Probably not. Let me explain why. But first, let me point out a few minor issues with the post above:
Minor Issues With a Restricted Property Trust
Conflict of Interest
Jason is an insurance agent with a business focused on selling restricted property trusts. I'm sure he's a nice guy and he might just be one of the most informed people on the planet about this infrequently-used, fancy scheme. He also has a massive conflict of interest in getting you to believe it is a good idea. If you Google “restricted property trust”, almost all search results are links from agents trying to use it to sell whole life insurance. There are no accountants, attorneys, financial advisors, authors, DIY investors, clients etc. out there anywhere advocating this technique in any easy to find place. Although there are a few attorneys offering to help you with the audits of your RPT. That should you tell you something.
Qualifying for Life Insurance
Second, unlike a retirement or taxable investing account or any other investment, you actually have to qualify for life insurance. If you are not healthy, have “dangerous hobbies” like SCUBA diving, mountaineering, flying, or skydiving, or are older, you may not be able to get this sort of plan at all, and even if you can the additional cost of the insurance is likely so high that it would make the plan a stupid choice for you. The life insurance might be “along for the ride” but you still have to qualify for it and pay for it.
Legality
Third, when the post starts out saying “I know all those other plans didn't end up passing IRS muster, but this one will,” you've got to ask yourself if you're really interested in getting involved in something that, at best, walks right up to the edge of legality, peers down, and then takes a half step back. As the old story goes, the best driver is not the one who can drive the closest to the cliff without going over.
Whole Life Insurance
Fourth, I hate the name. There's a reason Jason doesn't call it “Tax-deferred, business-owned whole life insurance.” Whole life insurance has a terrible reputation for a reason and calling it something else doesn't change that fact. One of his later paragraphs:
Now, if I told you this was all possible to do, but in order to do so and achieve the exact same results — it would require you use a whole life insurance policy as a funding vehicle. Would this change your mind?
is a classic sales technique. Yes, Jason, that would change my mind!
Returns
Whole life insurance is not a particularly attractive asset class. Yes, in the long run, you can expect bond-like returns, but in the short run, you should expect negative returns. That's not exactly a great swap.
Math
The math gets flakey later in Jason's post. The idea that you can somehow end up spending more money by using low returning whole life insurance instead of a more appropriately invested taxable account doesn't stand up to an appropriate analysis using appropriate return and tax assumptions. While he doesn't show his work, if it is like most comparisons made by insurance agents, it assumes that every dollar of return in the taxable account is fully taxed at maximum ordinary income tax rates, rather than enjoying tax-protected growth, qualified dividend rates, long term capital gains rates, tax-loss harvesting, and the donation of appreciated shares to charity. Even if the assumptions were fine, the comparison presents a false dichotomy in that it doesn't include using a Single Premium Immediate Annuity (SPIA) as a method of maximizing spending in retirement.
Major Issues With a Restricted Property Trust
Lack of Flexibility
My first major issue with using a Restricted Property Trust is the lack of flexibility. You must put at least $50K a year into it and you must do so for at least five years. One of the biggest problems that people run into with whole life insurance policies is that life changes, and now they're stuck with big fat premiums. We routinely underestimate how different our future will be from how we imagine it.
I mean, look at what happens if you can't make the premium payment one year. All of a sudden all of your past payments are given to charity? What's up with that? There is no such requirement on any other type of investing account. Why risk that much loss for such terrible returns?
Better Ways to Reach Financial Goals
My second major issue with an RPT is that it feels like a solution looking for a problem. What problem are you trying to solve here? Step back for a minute and ask yourself what the point is. The point is to reach your financial goals. If you're like most docs, one of your main goals is to save up a big nest egg to retire on. You want to minimize the effect of fees and taxes on the investments and you want to make sure you take enough risk to reach your goals but not too much risk.
If you make $300K a year, perhaps you save $60K a year for retirement. That easily fits into a $56K 401(k) and a single Backdoor Roth IRA. There's absolutely no reason for a doc with that income and those accounts available to go looking elsewhere for a place to save for retirement. Even for a higher earning doc, let's say one making $600,000 or even a million dollars a year, there are usually better options.
Let's take that doc making a million who wants to save $200,000 a year. How can she do that? Well, there's that $56K 401(k), maybe a couple of $6K Backdoor Roth IRAs, and a $7K HSA. Most likely, the spouse is contributing something to that income and brings access to a few more retirement accounts. Perhaps that's enough to shelter $120K of that $200K. Many docs also invest in a taxable account. That allows them to invest in real estate and some tax-efficient mutual funds they can use to tax loss harvest and even donate appreciated shares to charity. It's usually not terribly difficult to find ways to invest even $200K a year. Even for a doc who wanted a larger tax-deferred/asset-protected account, there is the option of a defined benefit/cash balance plan. I invested 7 figures last year and didn't seem to run out of good options to invest in that required me to go find an insurance agent.
So who is left that restricted property trusts could possibly be right for? Well, a pretty tiny sliver of doctors. I mean think about all of the requirements for a doctor to even consider this plan:
- The doc has to own her own practice (a small and dropping percentage)
- The doc has to make a lot of money (the average physician makes $275K, a small fraction of what someone should be making to consider this plan)
- The doc has to be a big saver ($50K should be a small percentage of their annual savings)
- The doc has to be in a practice where it doesn't make sense to have a big 401(k)/Profit-sharing Plan plus a Cash Balance Plan because her partners don't want to save much
- The practice has to file taxes as a partnership or corporation
- The practice has to have a business need for a big life insurance policy on this partner
- The practice has to have employees that would not value larger retirement contributions over additional salary (more on this later)
- The doc has to actually qualify to buy life insurance at a reasonable rate
- The doc has to remain in a stable earning situation for at least the next half-decade
We must be talking about less than 1% of doctors at this point. As I've always said about whole life insurance, it might be right for 1% of doctors. Well, I guess it wouldn't surprise me to find that an RPT is right for 1% of doctors. What are the odds that you're in that 1%? Not very good.
Few Practices Have a Legitimate Need for a $5 Million/Doctor Insurance Policy
In the example in his post, Mr. Mericle mentions justifying a $5 Million policy to the IRS as a legitimate business need, i.e. a key-man insurance policy. Perhaps he can convince the IRS of that, but more likely, the IRS just isn't looking very closely here. I mean, imagine you're in a very successful ENT practice where each partner is making a million a year. Let's say one of the partners keels over. Yes, the practice is now bringing in less money. Perhaps $2 Million less a year with similar overhead. But how long does it really take to hire a new ENT? Certainly no longer than a year and more likely six months and you don't have to pay that partner his $1 Million after he dies. What the heck is the other $4 Million for? Well, the only possible use is to buy out the deceased partner's estate.
Okay, maybe that flies with the IRS, maybe it doesn't, but the point is that the more you wish to put into this plan, the more you're going to have to justify the face value of the insurance to the IRS as a legitimate business expense. It's not like you can just say “I want to put $200K a year into this plan.” If you're 40 years old, that's going to be a massive death benefit on that policy that you'll need to justify. Mr. Mericle points out that you're really just doing this for the tax break and not the life insurance. You don't think that's also obvious to the IRS? Do you really want to be two or three years into this “retirement plan” and having to defend anything about it to the IRS?
Restricted Property Trusts are Only 70% Deductible
Your premium payment is not completely tax-deductible to the business. It is only 70% deductible. This is very different from a 401(k) or cash balance plan contribution that is 100% deductible. So now you're not only getting a crummy investment, but you're not even getting a full deduction for it! Are you really sure you want to do this instead of just paying the taxes and investing in a taxable account?
But Wait, There's More! (Taxes)
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Did you catch that bit in the case study about what happens after you get done contributing to this “retirement” plan for a decade and only getting a 70% deduction for your contributions? You get to pay more taxes. How much do you owe? Well, the value of the life insurance policy is basically compensation. It's FULLY TAXABLE. You're basically taking the entire cash value and paying taxes on it all at once at the end of year 5 (or 10 if you extend the plan). Perhaps after 10 years of $100K contributions it's now worth about $1 Million. You now owe taxes on $1 Million! You can either pay them from the policy or you can pay them from other assets, but pay them you will.
This isn't like a retirement account where you gradually take money out of the account over decades (or even leave it to heirs as a stretch IRA) and only pay taxes on what you take out. You pay all the taxes right now. And then what are you left with? You're left with a crummy whole life insurance policy you probably would have never bought in the first place if it hadn't been pitched as a tax-saving retirement plan.
Like most agents, Mr. Mericle loves to mention the “tax-free” aspect of spending that money. Well, it SHOULD be tax free. You've already paid taxes on it! If you surrender the policy and go and spend that million dollars, you're basically spending principal, which is always tax-free. Now it's cool that you can partially surrender a whole life insurance policy with gains and access the principal first. That's a legit tax benefit of cash value life insurance. But avoiding taxes on the basis/principal? Nah, that's the same with everything else. Same with being able to borrow against it tax-free but not interest-free. That's the same as your house, car, income properties, and portfolio. Borrowed money is always tax-free.
Hosing Your Employees
A few words should be said here about one other issue that isn't actually unique to an RPT. Many practice owners don't want to implement a traditional 401(k)/profit-sharing plan plus a defined benefit/cash balance plan because it will cost them a lot more in fees and required contributions for the employees than it will save the physician personally in taxes. I totally get it. There are reasons that The White Coat Investor, LLC doesn't have any employees outside of Katie and I.
Bear in mind that any time you choose a different retirement plan for your practice because of this concern that your employees may be getting hosed. Yes, maybe they aren't financially sophisticated enough to realize the value of a great retirement plan with a solid match and so aren't willing to take a lower salary in exchange for it, but proper education can go a long way in that department. There is a certain moral/ethical dilemma at play here in this regard that you should be aware of.
Restricted Property Trusts are Just Tax-Deferral
But I really don't think your employees should be feeling all that bad about missing out on this “retirement plan.” The only real benefit here is being able to wait ten years to pay the taxes on the money you used to buy a whole life insurance policy. In fact, as I understand it (and I could be wrong) I think you're paying taxes on 100% of the value of the policy when it is transferred despite only getting a 70% deduction on the original contributions! There's no way the tax-deferral is worth that arbitrage for most people, so I hope I'm wrong about that. But if the main point of this whole scheme is the tax savings, why aren't the details on the actual tax treatment more clearly spelled out? Probably because they're not all that good.
Personally, I'd rather just keep things simple, use the retirement accounts that make sense for the practice, pay the taxes, invest the money tax-efficiently in tax-efficient stock index funds, municipal bond funds, and real estate in a taxable account, and skip all this nonsense with a whole life insurance policy, a trust, and the charity for a relatively minor tax deferral benefit.
Does that mean there is NO ONE out there that would rather use this plan over investing in taxable? Of course not, but I don't know anyone personally that would want to do this once they understood how it really worked. Nor do I know anyone personally who is actually using an RPT. Do you really want to be the guinea pig? If so, let us know how it goes in the comments section.
What do you think? Do you have a restricted property trust? Why or why not? Would you consider using one now that you know what it is? Comment below!
This kind of thing does not apply to me as an employed doc but it is easy to see why it should be avoided.
IF you do not get the full deduction then you would be hard pressed to get a decent tax arbitrage. Without that there is no way to generate money in your favor. Obviously the insurance company needs to make something.
Under the most ideal circumstances you might get a little gain. But there are many ways to trip this up for big losses.
Thanks for the insight!
“A useful rule of thumb that has served decades of investors well is to never take any financial advice from someone who sells insurance…”
When you start an article with a statement like this, one that can’t be substantiated or defended, what’s the point of continuing to read the article? Your statement (which is purely emotional and not based in fact whatsoever) is no different than me starting out an article by saying a useful rule of thumb that has served decades of investors well is to never take any financial advice from a medical doctor.
That’s actually more believable and convincing than your claim, but I would still never say it because it accomplishes nothing and I can’t prove it’s even true. Further, if someone were to encourage me to not listen to you on financial matters because you are a doctor, that would make me want to listen to you more, because their argument has no validity (being a doctor doesn’t prevent someone from being a financial genius) and they’re making an emotional argument probably because they feel like the numbers behind the rest of their argument don’t stand on their own.
Thanks for your feedback.
Will – it would seem that someone with multiple investment options and no legally required fiduciary responsibility might, perhaps, maybe push investors towards higher commission products. It is conceivable that, as WCI suggests, they might have a personal interest in making money. Perhaps that could be seen as, I don’t know, a HUGE conflict of interest. Legal, absolutely, but a conflict interest. Is it emotional to think about how the person across from you gets paid? What would you see as WCI’s conflict of interest in offering a pro/con piece like this?
Ben, you seem to have bought WCI’s claim. You (and apparently WCI) think that someone who has a life insurance license ONLY has a life insurance license. That is absurd. I’m certain that there are many people who just sell life insurance and only have a life license, but to make a blanket statement that you should take no financial advice from someone because one of their licenses/credentials happens to be a life insurance license, is not defensible in any way.
I’m curious — how much commission does an insurance agent receive from advising a client to invest in low-cost index funds through Vanguard or Fidelity? And how much commission does an insurance agent receive from selling a complex instrument with dubious value?
This bias toward generating revenue at the expense of others is of course not unique to insurance agents, and it would be unfair to imply so.
For example doctors who have invested in an xray machine in their clinic are much more likely to use it even in marginal cases. Just as insurance agents convince themselves that complex instruments are a good thing for their clients, doctors with an xray machine will xray behind that wart they’re removing for little Johnny, just in case a broken bone is hidden underneath!
Not sure why you two read this blog when you are not the target audience for the blog, but its subject.
If I ran a business, you can bet I would know my margin on various services offered. Is it unreasonable to assume that that would be the case for a financial advisor? I know I had to go through several dog and pony shows about whole life and universal life insurance while trying to line up a term life policy. In each case I had started off with a clear statement that I was ONLY interested in term life insurance. What incentive do you think was driving this agents? Could it be the commission? Is it emotional or logical to suggest this?
Ben, here’s why you had to go through a dog and pony show about whole life and universal life: because whoever you were talking to wanted to make sure you were making an informed decision. Imagine going to an MD and telling him exactly what prescription you want. It doesn’t work that way. It’s not a perfect analogy, but I think you get my point. Anyone selling anything is not going to merely bow to the wishes of a prospective customer without at least making them aware of their options.
That’s laughable that being legally allowed to sell someone crummy loaded mutual funds AND whole life insurance somehow qualifies that person to give financial advice. Despite the fact that my point is obvious to everyone that doesn’t sell financial products, I don’t expect someone who does to agree with me because as Upton Sinclair said:
Like a doctor giving financial advice.
Maybe I should get medical advice from my plumber.
You’re the one reading it. If you don’t like my peaches, don’t shake my tree.
Thanks to Jason Mericle and Jim for starting a good debate. This is a product I have never seen before.
“When the policy is transferred there will be additional taxes owed. The tax payment is most commonly paid by taking a withdrawal from the policy.”
I completely missed this in my first read through of the policy description. It was only after reading the WCI “con” section that I went back and found this. Up until that point, I was thinking, “Hmmm, seems like an interesting way of getting some tax-free money later on in life…”
And Jim is right that the math is a little fuzzy.
$68,500 invested for 10 years with 8% compounded growth should be: $1,071,715.89, not $874,000 as stated above. I’m not sure how he’s getting that number, even if you consider some of the capital gains / dividends being taxed at long term capital gains rates.
Would love to hear the math behind your calculation here, Jason.
Thanks,
— TDD
Agree completely. There’s not enough information put forth by Jason for me (personally) to know if this is something worthwhile or not. Hopefully he is notified that this was posted and gets involved in the discussion. I’m especially interested in the tax on the way out.
First, I appreciate all the comments. I will respond to them individually later today. I wanted to start by taking a brief moment to “debate” Dr. Dahle’s issues regarding the Restricted Property Trust.
First, I agree with him that whole life insurance isn’t always the best vehicle for individuals to reach their retirement goals. Unfortunately, many agents and advisors out there don’t explain (and sometimes don’t understand) the product itself and how it works.
Let me begin by saying the Restricted Property Trust is not for everybody. There must be a business need for life insurance coverage and the participant needs to be able to commit to funding it for a minimum of $50,000 per year for 5-years. It is possible that these two requirements eliminate 98-percent of the readers of this blog. But, for the remaining 2-percent it can be incredibly effective and useful.
The challenge with Dr. Dahle’s comments (especially on whole life) are general statements. It’s very difficult (and sometimes dangerous) to provide financial advice from this perspective. Everybody’s needs, goals, and wishes are different. It’s only when you understand these three things is anybody able to advise what to do.
In terms of Dr. Dahle’s major issues I’d like to address them individually:
1. Lack of Flexibility
The lack of flexibility is what has allowed the Restricted Property Trust to outlast all the other insurance “schemes” that he has mentioned. These other plans he references lacked flexibility, and largely because of that they were penalized.
Because the plan has minimum funding and length funding requirements it makes it favorable to the IRS. Without these it would be like broadcasting that it was a scam if they didn’t exist. Having the charity in place for failure to meet these requirements only strengthens its defense with the IRS.
2. Better Ways to Reach Financial Goals
I really don’t disagree with anything he has said here. I’m not going to make general statements. We look at pension plans, SEPs, etc. to determine if there are better vehicles available. Why wouldn’t you?
This plan is for physicians who have a medical practice making $600,000 or more. The good news is most high-earning physicians have stable and consistent incomes. One of the biggest benefits of the plan is that it does not affect contributions to existing pension plans. So, it can be setup on a standalone basis or in addition to an existing plan.
3. Few Practices Have a Legitimate Need for a $5 million policy
If you are in a successful ENT practice where you and your partner are each making $1 million per year there is value to that practice. Now, we would have to look at the tax returns and financials to determine the value along with other factors.
The problem I have with Dr. Dahle’s statement is when he focuses on the fact that it would be easy to find another doctor to replace them. What about the family of the deceased doctor? Does the practice have no value to the surviving family members? As a physician in private practice would you be okay if your family received no value for your life’s work?
4. Restricted Property Trust are only 70% Deductible
Dr. Dahle is absolutely right here – the net deductible amount is 70-percent and it’s 100-percent deductible in a 401(k). Conversely, the distributions from the whole life insurance policy are 100-percent tax-free. In a 401(k) all income received is 100-percent taxable at ordinary income rates.
5. But Wait, there’s More! (Taxes)
Again, Dr. Dahle is absolutely right. A tax is owed when the policy is transferred to the participant. He’s not correct in that you’re paying taxes on the entire cash value.
Again, this is key to why the Restricted Property Trust has outlasted every other plan that included a deduction and life insurance. Restricted Property Trust is more of a mechanism for deferral than deduction. The other plans were purely deduction driven. The fact that we are paying some taxes along the way is largely why the plan has been so successful with the IRS.
6. Hosing Your Employees
My only comment is if you’d like to include your employee as a part of the Restricted Property Trust then you can. If you don’t, then that’s fine too.
7. Restricted Property Trust are Just Tax-Deferral
You’re not paying taxes on 100-percent value as mentioned above, and it is a mechanism for deferral and deductions. The combination of the tax deduction and tax treatment of life insurance can make the Restricted Property Trust a great vehicle for the right person. Again, it isn’t for everybody.
There are currently hundreds of Restricted Property Trust’s being funded throughout the country. A large portion of them are physicians do to their ability to earn high, consistent incomes.
If you are in a position where your CPA or Tax Advisor’s don’t know of any additional ways to help you reduce taxes this may be one option.
3. Of course the practice has value to the estate. So the new partner or existing partners have to buy the estate out. If the buy-sell agreement requires key-man insurance, that’s fine. It certainly doesn’t require a RPT.
4. Distributions from whole life are not “100% tax free.” You can do a partial surrender and get our basis back tax-free (like any investment where basis is tax-free.) You can borrow against it tax-free (like any investment). But you cannot do a complete surrender and expect tax-free treatment of your gains. It doesn’t work like that. In fact, those gains are taxed at higher ordinary income tax rates, not the preferred LTCG rates.
5,7. So…..how much tax are you paying on the cash value? You don’t say in your post. You don’t say in your comment. I can’t find it anywhere on the internet. How is the tax determined? This is perhaps the most important factor in deciding whether or not to buy this product, and yet nobody will tell the prospective buyers how large the factor is. If it’s 10% taxable, it’s a great investment. If it’s 90% taxable, it’s a terrible investment. But how can someone tell without that info?
3. You stated that few practices have a legitimate need for a $5 million policy. I simply provided a reason why there actually is a business need for this amount of death benefit, which you have just confirmed exists.
There are several ways that a practice may choose to buy-out a deceased or disabled partner. It could be cash flow, bank loan, term insurance, RPT, etc. I’m not here making a blanket statement that RPT is right for any and all situations. It is merely an option.
4. If the intent is to surrender the policy once the participant has completed funding the RPT I would suggest that RPT is not the right vehicle. It would be a foolish decision.
5,7. Based on this example the taxes owed once the policy is transferred to the participant are projected to be $220,959 (or approximately 20.5% of the Year 10 cash value).
4. So if someone doesn’t actually want a whole life policy long-term, they shouldn’t buy an RPT. I agree with that.
5,7. How are you projecting that amount of tax? How is the calculation made? And if it really is a 70% deduction up front and a 20% payment on the backend, how is that just tax-deferral and not a tax-deduction as you claimed in the post?
4. If somebody intends to buy a whole life policy for short-term purposes they shouldn’t do so either within RPT or outside of RPT. If somebody wants a deduction, tax-deferred growth, tax-free income and they want to use RPT to help them accomplish that then the whole life policy is necessary (which I will cover further in my next answer).
5,7. The 83(b) portion, or the Paid-Up Additions (PUA), is tied to the US insurance carriers’ Return on Equity (ROE) on the whole life block of business. Life insurance is not a capital asset under IRC 72.
A dividend is a return of premium, and therefore not capital growth. The only capital growth component of a whole life policy is the underlying ROE of the carrier’s block of business. Therefore, we grow the PUAs on a time value of money equation to determine what is taxable and non-taxable at the end participation.
This is also why we have to use PARTICIPATING whole life insurance products. In this type of contract the policy owner “participates” in the carrier’s risk and reward, and therefore has a right to grow the 83(b) property by this amount. The good news is this is the most profitable piece of business for every insurance carrier in the world and last year the ROE was over 14%. That said the 20 year look back is well into the double digits.
The taxation at the end of participation is: Total Cash Value – (83(b) property + growth attributable to the 83(b) property) = the income taxable amount. The beauty of this deferral mechanism is by submitting to the risk of forfeiture we are essentially taking out all the insurance costs, commissions, etc. that suppress the cash value and buying whole life insurance with leveraged dollars. Based on historical ROE’s we are using a 12% growth rate on the 83(b) property.
Assuming a 50-year-old client is still in a 45% tax bracket and contributed 10 years at 100,000 per year:
– Cash value in year 10: $1,080,657
– $30,000 per year at 12% for 10 years= $589,637
– $1,080,657 – $589,637 = $491,020. At 45% that would be $220,959.
4. They probably shouldn’t do it at all. It works out “okay” in the long run, but never works out anything but terribly in the short run. Even in the event of very early death, one (or rather one’s estate) would have been better off with a 10X sized term policy!
You’re using the phrase “tax-free income” again, which is incorrect. Tax-free income is what you get from a Roth IRA or a muni bond fund. What you get from a whole life insurance policy is not income ta all. Let’s call it what it is–“access to your own assets in the usual tax-free manner.”
5, 7 Interesting to see how the tax is calculated. I’m curious how much the tax rate depends on that big 12% assumption. Obviously a 70% deduction going in a 20% something tax payment going out is at least attractive enough to make the plan more attractive than the typical whole life policy. I suppose what one must really do is run the lower returns of whole life up against the additional tax break to decide if it is worth it and for how long.
You made the assertion earlier that this plan “works” with the IRS because it is just tax-deferral, not tax-avoidance. But it looks like tax avoidance to me (the “tax arbitrage” is what makes it attractive) but I still wonder what the IRS would do if this were to become popular given past history on other business owned life insurance schemes.
White Coat Investors. Do you know what’s funny? What’s funny is the fact that my thoughts about life Insurance were just like yours when I was a Financial Advisor with Merrill Lynch. And why? Because that’s how I was trained! I was trained to look, create and express negative things about life Insurance, and I did it for years until one day, just by coincidence, I learned how much money the two banks I bank with had in Cash Value Life Insurance, and most importantly, why they had so much money in it. Bank of America currently has $22 Billion dollars and Wells Fargo has $19 Billion dollars in Cash Value Life Insurance. After that shocking news, then I learned that every single Banking Institution member of the FDIC also have hundreds of millions and tens of billions in Cash Value Life Insurance, then I understood what was happening! So, 7 years ago, I left Merrill Lynch for an insurance company! Now I am happier than ever because of the things that I am able to do for my clients, their families, their businesses and their employees. So before you continue on this path of talking garbage about a product that do so much for people and the community, learn how much money your own bank and its executives have in Cash Value Life Insurance and do the same for your clients. The numbers are there! The tax advantages are there as well. The problem is people like you and people like I just to be, don’t truly understand what Cash Value Life Insurance does for people not what it is. And for those reading this post, please try to learn more from people who are actually available to educate you and not see you as a transaction. There plenty of people like me out there are genuinely willing and able to educate. The money will come, and it has come my way, but ONLY because I made the decision to educate and not to sell. Cash Value Life Insurance has ONLY one purpose—to make money when you needed the most. Wall Street is the only place where money makes money! However, the best investment is the one that gives you the most money—that’s Cash Value Life Insurance! Period!
I am a Financial Planner and I work closely with dentists, physicians, business owners and successful executives and their CPAs! You can learn more at http://www.dotchadvicedentists.com
Lastly, the creation of qualified retirement plans such as 401(k), SEP and Defined Benefit Plans and its LIMITS, created a what I called Reversed Discrimination towards business owners and highly compensated people, and that’s because their salaries prevents them from contributing larger/higher amounts for retirement. However, the ONLY tool the IRS would allow anyone to actually contribute larger amounts for retirement and not be subject to Department of Labor and ERESA rules, is through a well designed Cash Value Life Insurance with not limitations!
The bank/executive angle has already been discussed on this blog.
https://www.whitecoatinvestor.com/what-you-need-to-know-about-whole-life-insurance/
Perhaps the reason there are limits on qualified plans and not insurance is because one of them is actually a good deal tax-wise.
I find the concept interesting and well thought out.
I have one thought/question to consider. When the market takes downturns, as it often does, doe your equity portfolio go down? When the market crashed did you portfolio go way down? Did it take a long time for the values to go back up? Well, my Whole Life policy values did not go down and they kept growing.
A bit of a silly argument if you don’t look at overall returns. Would you rather have a 3% return that never goes down or a 9% return that goes up and down all the time. I’d take the latter for any money I don’t need for a long time. Add in the fact that the 3% return investment has a negative return for 5-15 years and it becomes a no-brainer.
I’m not sure where you’re getting the 3-percent. The policy we use for the Restricted Property Trust has a current dividend rate of 6.10% and a guaranteed rate of 4-percent. Most whole life insurance policies in the marketplace currently have a dividend rate of 5% or more.
In reference to a negative return in years 5-15, it would clearly be impossible based on a policy that is contractually obligated to pay no less than a guaranteed 4-percent.
You may be talking about dividend rates where I was referring to the total return.
Jason, stating a “guaranteed 4-percent” return is inaccurate and misleading. (Remember, I’m not anti-whole life.) When someone says a guaranteed 4%, people naturally conclude that if you put $100,000 into it, you will have $104,000 after one year. What do you mean when you say “guaranteed 4-percent”?
You are correct. If you contributed $100,000 today you would not have $104,000 at the end of the year. Because it is a permanent life insurance policy there are administrative, mortality expenses, commissions, etc. Any excess above these expenses become cash value in the policy. In some cases, policy cash values may also be used to pay these costs.
Any net policy values (after expenses) are then contractually obligated to receive a dividend no lower than the guaranteed dividend rate of the whole life insurance policy/contract. It is important to note the guaranteed dividend rate can vary from policy to policy.
There is always this fear of taxes.
Why do we all fear taxes?
It seems some people would be happier ending up with less money if only they had less taxes.
It does not make sense.
TDD-
Great question!
A whole life insurance policy is an asset class comparable to cash, money markets, CDs, and bonds. Because of this, when we calculate the account balance we assume we are paying ordinary income taxes on the gain for the year as you would on these types of asset classes (provided they aren’t tax free bonds).
For example, $68,500 x 8% would result in interest of $5,480. At a 45-percent tax rate the individual would owe taxes of $2,466. The net end of year account value would $68,500 plus $3,014 ($5,480 less $2,466) equaling $71,514.
Also, as a point of correction in my prior post contributions to a Restricted Property Trust do NOT affect contributions to existing pension plans.
If you have any additional questions please let me know, and I’ll do my very best to explain.
Jason
Jason, where are you getting 45% from? Seems a bit high to me. Is that arbitrary or did you pick it for a reason?
Jason,
Why are you implying that 8% gains are getting taxed at marginal rates every year? That would only happen if you turned over your entire portfolio every year, with earnings taxed as ordinary income at short term capital gains rates.
As has been alluded to by Jim and others, whether intentionally misleading or not, qualified dividends and long term capital gains rates are significantly less than ordinary income marginal rates for your target audience. Further, artifactually inflating tax drag in a taxable brokerage account also falsely diminishes both real returns and exponential multipliers from compound interest. Not to mention tax loss harvesting and other tax minimization strategies.
Apologies for seeming trite, but you seem to be selling a convoluted strategy for tax savings based on flawed assumptions about mainstream alternatives which are less risky and far more appropriate for 99.9% of Dr. Dahle’s readers.
Phil,
First, thank you for your comments and I don’t consider them to be trite. Since a whole life insurance policy is being used, we are making a comparison to similar asset classes that are usually taxed on an annual basis at ordinary income tax rates like CDs, savings and checking accounts, most bond interest payments, etc.
If the cash value was driven by market returns, then it would make sense to compare it to an investment portfolio under a long-term capital gain scenario.
JM
Corrected the prior post.
The problem with this sort of tax comparison is it maximizes the comparative performance of whole life insurance inappropriately. In reality, if you were going to hold taxable bonds or CDs you should be doing it in a retirement account and hold stocks in taxable.
WillCD,
I don’t disagree with you. Something closer to 40-percent as an average would likely be a better representation on a national level. In California it’s more than 45%, while in states like Florida it’s 37%. This still won’t affect the numbers by a huge amount, but would definitely have a slight impact.
Jason
I found this article through a link in a recent post. I read it when it originally came out and thought ok that’s not for me. Now I’m not so sure. I’m currently putting away 400k in investments. I’m in small group practice. None of my partners will consider a Cash Balance Plan because they don’t invest more than the profit sharing amount per year. So a large part of my investing is now done outside of tax protected methods. Let me see if I understand based on 100k per year for 10 years (assuming no change in tax rates) total $1M put in.
Deduct 700k * 45% = 315k.
At 10 years if the estimate above is accurate owe $205k in tax immediately.
So theoretically you come out 105k “ahead”? 105k over 10 years mean you were about 1% per year ahead? Am I missing something? I guess I get to use that 315k over the 10 years so there’s some advantage there potentially…
But what happens if I move or become disabled at year 9? Also the benefit goes to the corporation and not my estate directly. I lose the whole thing If something happens. Sounds pretty risky for a 1% return. When I’m done at 10 years am I done paying premiums? Then it’s just a cash paying whole life policy over time?
I guess I was thinking if anyone was in the 1% who it would help it would be me with my income, high savings rate, S Corp, partners who don’t want to participate, maxes out tax benefited space. But even so I am leaning toward it not making sense for me. I really want it to since I want more tax smart options so please convince me!
Great pro/con though. Appreciate both of you and your thorough arguments.
Just because I said there could be 1% of docs for whom it could be right doesn’t mean there actually is. 🙂
I still don’t see a use for it for me for instance.
Curious,
Thank you for your comment. The economic results will vary from individual to individual, but your summation is on the correct path. If you would like to discuss your individual needs I would be happy to do so.
Additional benefits of the RPT occur once funding of the RPT is complete and you take ownership of the policy. If or when you decide to take distributions from the policy they will be tax-free in the form of withdrawals and policy loans. In addition, if you pass away the death benefit proceeds will be payable to your beneficiary income tax-free.
In reference to a disability, we do have an option to include a Waiver of Premium rider to the policy. This will have a small economic impact on the plan, but if a disability were to occur the policy would continue to fund itself.
When the plan is established you name your own beneficiary. If death were to occur while funding RPT, the trust would receive the death benefit and the proceeds would be paid to the named beneficiary of the trust (e.g. spouse). It would only be paid to the corporation if you made the corporation the beneficiary of the trust.
Assuming you no longer want to make contributions to the RPT beyond Year 10 the policy would be distributed to you. It would then become a Reduced Paid-Up whole life insurance policy, which would not require any additional premium payments. You are correct that when this occurs it becomes a cash-paying whole life insurance policy.
Please let me know if you have any additional questions or if you’d like to discuss further. You can visit our website by clicking my name above. Thank you for your interest and well-thought-out comment.
Jason
Lance WallachJanuary 11, 2017 at 5:17 AM
Jeff Gerber
FollowJeff Gerber
Ins. Life Disability Long Term Care Health
Interesting ideas are being touted as the latest and greatest uses of Life Insurance for obtaining enormous tax savings. This idea is not really new and makes use of certain tax codes eg. 419 and 419(e). The plans have typically used lousy life insurance plans (the plan works better that way) and the IRS has reviewed bits and pieces of this area of tax law for years. These RPT’s may fall under Listed Transactions connected with Benefit Plans. Go for it but you CPA’s out there make sure you have a ton of E & O insurance.
Jeff Gerber
Ins. Life Disability Long Term Care Health
Interesting ideas are being touted as the latest and greatest uses of Life Insurance for obtaining enormous tax savings. This idea is not really new and makes use of certain tax codes eg. 419 and 419(e). The plans have typically used lousy life insurance plans (the plan works better that way) and the IRS has reviewed bits and pieces of this area of tax law for years. These RPT’s may fall under Listed Transactions connected with Benefit Plans. Go for it but you CPA’s out there make sure you have a ton of E & O insurance.
Assuming the RPT works, a better insurance option would be a commission free policy from Ameritas
Apparently Mr. Mericle was using Penn Mutual which I can’t confirm since the company wasn’t mentioned.
[Solicitation of business removed. Also, please provide more context with your comments (and only post them once). I think this one is pointing out someone that got into trouble for recommending a restricted property trust to clients.]
FINRA
Allegations
Without admitting or denying the findings, Crabb consented to the sanctions and to the entry of findings that he willfully failed to amend or timely amend his Form U4 to disclose federal and state tax liens totaling nearly $1. 7 million. The findings stated that the Internal Revenue Service (IRS) filed seven tax liens against Crabb, and the State of Ohio filed four tax liens against Crabb. Crabb disclosed one federal lien approximately seven years after learning of the lien’s existence, one federal lien and three state liens approximately two years after learning of the liens’ existence, and two federal liens approximately one year after learning of the liens’ existence. For three federal liens and one state lien, totaling more than $ 1.1 million, Crabb failed to make any disclosure at all. With respect to three of the liens that he untimely disclosed, Crabb represented on his Form U4 that the liens were satisfied when they were not. The findings also stated that Crabb falsely attested on his member firm’s annual compliance questionnaires that he did not have any unsatisfied judgments or liens.
Resolution
Acceptance, Waiver & Consent(AWC)
Sanctions
Civil and Administrative Penalty(ies)/Fine(s)
Amount
$5,000.00
Sanctions
Suspension
Registration Capacities Affected
All Capacities
Duration
six months
Start Date
3/2/2020
End Date
9/1/2020
Sanctions
The settlement includes a finding that Crabb willfully failed to disclose a material fact on a Form U4, and that under section 3(a)(39)(f) of the Securities Exchange Act of 1934 and Article III, Section 4 of the FINRA By-Laws, this omission make him subject to a statutory disqualification with respect to association with a member.
Regulator Statement
Fines paid in full on September 23, 2020.
Disciplinary Action Details
Its incorrect that you pay taxes on the entire amount after 5 or 10 years. You stretch out the taxation by leaving the policy in the Trust, and taking Distributions from the policy and paying it as income to the Owner.
Also, only around 50% of the distributions/income to the Owner is taxable. This is technically a “Welfare Benefit Program” and the Base Premium of the WL policy is considered a return of unused Benefits.
Welcome to 2022. It’s been 3 years since this post was published. At that time, our “expert” on these plans wrote this:
I have no idea if he is right or you are right, but the fact that even those selling it don’t know how it works is a reason not to buy in my opinion.
IRS AUDITS CRYPTOCURRENCY, CONSERVATION EASEMENTS AND CAPTIVE INSURANCE
Cryptocurrency audits by the IRS. Cryptocurrency compliance investigations may also turn into larger, criminal tax investigations. CONSERVATION EASEMENT AUDITS With the increased reporting requirements, IRS audits of conservation easement transactions have greatly increased. Instead of working collaboratively with taxpayers to seek a reasonable resolution, Revenue Agents are being directed to disallow deductions no matter what. With a high percentage of cases headed to litigation, taxpayers need to take every step to protect themselves now. With the increased reporting requirements, IRS audits of easement transactions have greatly increased. Instead of working collaboratively with taxpayers to seek a reasonable resolution, Revenue Agents are being directed to disallow deductions no matter what. With a high percentage of cases headed to litigation, taxpayers need to take every step to protect themselves now. CAPTIVE INSURANCE AUDITS Another IRS audit target is captive insurance.
Interesting ideas are being touted as the latest and greatest uses of Life Insurance for obtaining enormous tax savings. This idea is not really new and makes use of certain tax codes eg. 419 and 419(e). The plans have typically used lousy life insurance plans (the plan works better that way) and the IRS has reviewed bits and pieces of this area of tax law for years. These RPT’s may fall under Listed Transactions connected with Benefit Plans. Go for it but you CPA’s out there make sure you have a ton of E & O insurance.