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Testing
Financial Tolerance For
Private Retirement Plans (Part 4) Part 3 of this series examined the use of a reverse split dollar plan to fund the purchase of a variable universal life insurance policy for Tony and Samantha Callahan, ages 45 and 40. The planned retirement age of this couple occurring 20 years hence dovetailed nicely with the accumulation phase of the policy. Due to surrender charges, such policies must run 15 to 20 years before they have seasoned sufficiently to produce cash flow for retirement income. What happens if the couple is closer to retirement? Case Study Background: Let's examine the case of Michael and Mary Kate Murphy, ages 55 and 50 respectively. He is owner and CEO of Murphy Trucking, Inc., and she is a self-employed architect. Their gross income exceeds $700,000 and, after tax, their net income is $450,000. Their current Net Worth is $4,000,000. Please take a moment to examine their assets on the Client Information Summary from our InsGift System by clicking here. Michael and Mary Kate expect to retire in 10 years. Michael typically leaves no profits in his business -- rather, he tends to pay himself a substantial bonus at the end of each year. He and Mary Kate are willing to leave the last $100,000 of bonus in the corporation for each of the next five years -- assuming it can produce efficient results. Let's examine a reverse split dollar arrangement involving variable universal life insurance. The plan involves $1,600,000 of coverage bearing five $100,000 premiums paid by Murphy Trucking with policy loans of $175,000 a year starting after 20 years payable to Michael and Mary Kate -- 10 years after their expected retirement. Query: Can this couple realistically be expected to be interested in a plan that produces no retirement income until 10 years after they retire? Let's see . . . Solution: We will measure their current retirement plan against a revised plan that includes their share of the reverse split dollar arrangement. Note: Their current retirement plan calls for $240,000 of after tax retirement income in today's dollars -- indexed at 3% for a cost of living adjustment. This means that, in 10 years, their first retirement payment must be $322,540 and, if they both live another 30 years thereafter, their cumulative after tax retirement cash flow must total $15,344,972. Fortunately, using Michael and Mary Kate's own assumptions, their current plan does provide for this level of retirement cash flow -- with plenty left over. After deducting the required retirement cash flow, their Net Worth under their current plan -- using their assumptions -- is projected to grow from its current base of $3,750,000 to almost $17,000,000 during the 40 years studied. That is reflected in Strategy 1 in the InsGift graphic below. Strategy 2 injects the reverse split dollar numbers. As you can see, it will cost this couple almost $10 million in long-range Net Worth if they don't utilize this financial technique! During the early years of the analysis, there is a slight dip in their overall Net Worth -- due to policy surrender charges. (With a lighter load policy, this could be mitigated.) However, by year 9, Strategy 2 takes the lead and the spread widens considerably thereafter. The heirs are better off as well -- by almost $4.5 million as the graphic below demonstrates.
Note: In the above graphics, the dip in values at 65/60 is due to the capital gains tax associated with the sale of Murphy Trucking (as planned by Michael and Mary Kate). Compensation Analysis: If Michael's compensation is reduced by $100,000 a year, in his 45% income tax bracket, it will cost him $53,550 a year (counting his Medicare tax savings, too). As we did for the case in Part 3 of this series, we had InsGift "find" this money for him. In other words, we reallocated $53,550 of his and Mary Kate's assets to supplement their spendable cash flow during the first five years of the Strategy 2 analysis. Consequently, their $10 million gain in long-range Net Worth is created without their having to reduce their spendable cash flow by the after tax cost of Michael's compensation adjustment. Conclusion: It is not difficult to market a plan like this when there is no personal out-of-pocket cash flow cost to the funding. This couple may also be interested in wealth preservation, so this is by no means the end of the evaluation process for them. The procedure outlined in this article allows you to claim them as clients now with a database of their assets, and you have all the information needed to next prepare wealth preservation strategies for their consideration. Illustration Systems: The reverse split dollar data was developed in our Leveraged Compensation Plan (LCP) System. If you are not licensed for it and/or the InsGift System and want more information, contact an InsMark Account Executive at 1-888-InsMark (467-6275), or click here. Note: In LCP, we used a 22.25% corporate income tax bracket calculated as follows: 15% on the first $50,000 in retained profits plus 25% on the next $25,000 plus 34% on the next $25,000. The effective bracket averages 22.5% on the $100,000 of retained profits used for the reverse split dollar plan. (LCP also illustrates equity split dollar funded via compensation adjustments.) Space prevents the inclusion of the various backup reports from InsGift that support the graphs displayed in this issue; however, you can review the year-by-year numerical results of the InsGift portion of the analysis by clicking here, and the reverse split dollar numbers by clicking here. Downloading Data: Leveraged Compensation Plan users can review all reports and related menu inputs we used to create the reverse split dollar analysis in this issue by downloading the LCP Workbook named LCP119.!wb from the Workbook Download section of this website. On our main webpage, click on Producer's Center, then click on the Workbook Download icon at the top of the next page, then click on Marketing Alerts. To download now, click here. InsGift users can review all reports and related menu inputs we used to create the Net Worth analysis in this issue by downloading the InsGift Workbook named MA119.!wb from the Workbook Download section of this website. On our main webpage, click on Producer's Center, then click on the Workbook Download icon at the top of the next page, then click on Marketing Alerts. To download this workbook now, click here. After downloading, you can import either Workbook by clicking on Client Workbook/Import Workbook on the Main Toolbar of the corresponding System. Note: This overall strategy will also work for those who are younger than Michael and Mary Kate. Part 3 of this series covered a situation similar to Michael and Mary Kate's, but involved a younger couple. |
