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Issue Date: Vol. 52, No. 6, June 2012, Posted On: 6/9/2012


How To Use The Tax Law To Boost Your Annual Income While Increasing Your Family’s Wealth


by Irv Blackman
income tax, vending business planning, coin machine business, succession plan, Irv Blackman, estate tax, small business, succession planning problems

Most readers who contact me have a tax question or concern. No doubt about it, taxes -- income and estate -- lead their anxiety parade. Can you guess what's in second place?

Hands down, it's a troika of goals: (1) how to increase income on invested assets; (2) not lose invested capital and (3) most of all, what (if any) are the alternatives to the stock market. Each question/concern contains a common denominator: invested assets. Most of the assets are funds in some kind of qualified plan (i.e. an IRA, 401(k), profit-sharing or the like) or other funds that have been accumulated over their lifetime. Sometimes the funds are in a trust, partnership or other entity controlled by the reader. The struggle is always he same... how to invest the funds. All such funds are the subject of this article.

No, there is no attempt -- either directly or indirectly -- to give you investment advice. But let me be clear: historically low interest rates, the lousy economy, the uncertainty of Wall Street (stocks and bonds) and other negative factors (domestic and international) has created a current investment problem that seems to have no known solution.

What to do?

Enter the tax law and tax-advantaged investments. The strategies you are about to learn work whether you are (a) a little guy just trying to maintain your lifestyle, (b) have $20 million (or more) to invest, or (c) anything in between.

Ready, time to go to work. For tax purposes there are two types of funds you can invest: (1) qualified funds (for example, an IRA which is subject to double taxes, both income and estate) and (2) non-qualified funds (You paid income tax when you earned it or received the funds by gift or inheritance. Such funds can only be subject to one tax -- estate tax -- when you die.)

It should be noted that there are an endless variety of tax-advantaged strategies to accomplish your investment goals. The examples that follow are the two strategies we use most often in our real-life tax practice.

Income Booster Strategy (IBS)

Larry is a little guy (in a 25% income tax bracket/not enough wealth to worry about estate taxes). He is 70 years old and retired. Joe, on the other hand, is a well-to-do business owner, also 70, and intends to keep working forever (albeit at a slower pace)

The example below shows the results for Larry (invested $250,000 in an income contract) and Joe (invested $2.5 million). The annual income from the income contract is divided three ways: (1) pay income tax, (2) pay the premium on a life insurance policy to replace the amount invested, and (3) the balance is spendable income. Before starting their IBS both were earning only 2% on their non-qualified funds.

  Larry    Joe   
  Before After Before After
 Annual Income.        
   - 2% of Investment $5,000   $50,000  
   - Income contract   $25,400   $254,000
  Less-Income Tax -1,250 (5,100)* -17,500 (61,000)*
  Less-Premium _______ -8,900 ___________ -89,000
  Spendable Income $3,750 $11,400 $32,500 $104,000
  % after tax 1.50% 4.56% 1.30% 4.16%
         
 Insurance proceeds $250,000 $250,000 $2,500,000 $2,500,000**
 Estate tax _____-__ ___-____ -1,375,000 ____-___
 To Family $250,000 $250,000 $1,125,000 $2,500,000
         
 *Portion excluded from income under tax law      
 **To irrevocable life insurance trust (free of estate tax)    

The numbers speak for themselves: more "Spendable Income" (over three times as much after tax), more "To Family." Thank you tax law.

Qualified Plan Rescue (RPR)

The cast of characters are identical. But this time the funds are in a qualified plan (a rollover IRA), which was earning 2%.

In this example the IRA funds are used to buy the income contract, a tax-free transaction at its inception (again, thank you tax law). However, each annual payment (when received by Larry and Joe) is subject to the full income tax rate, the same as if a distribution had been made by the IRA.


  Larry    Joe   
 Cost of income contract $250,000 $2,500,000
 Annual income $25,400 $254,000
 Less-Income tax 6,350 88,900
 After-tax Income $19,050 $165,100
 Insurance Premium    
    $250,000 policy 8,900  
    $4,642,000 policy          - 165,100
 Spendable Income $10,150     - 0 - 

 

Larry locked in $250,000 for his family (via the life insurance), while he will enjoy a $10,150 income per year for life (4.06% after tax on the $250,000). Joe, on the other hand (because he does not need the income) chose to use all of his "After-tax Income" to purchases life insurance for the extraordinary face amount of $4,642,800… 100% tax-free (no income tax, no estate tax). (Note: If Joe had been married, he could have bought second-to-die life insurance -- an additional death benefit of about $1.5 million -- for the same premium cost.)

Now a question: How much would Joe's family have received if he got hit by the proverbial bus without doing an RPR? Only about $750,000 because of the double tax -- income and estate -- on qualified plan money. So the RPR strategy turned $750,000 of after-tax money into $4,642,800 (tax-free) for Joe's family. As my grandkids say, "Awesome."

The RPR strategy is flexible and can be designed to do tax miracles to accomplish your specific goals. If you have a large amount (use your personal definition of large) in a qualified plan, you owe it to yourself and to your family to check out a RPR.

Important note: What the exact numbers would be for you in each of the above examples are influenced primarily by your age, your health and interest rates. Also, the skill of your advisor impacts the final results. So, don't mess with an amateur.

Sure, sure, you want to know how an IBS or RPR might work for you, your Mom/Dad or your grandparents.

So, I have made arrangements for readers of this column to get (from an experienced professional) all the information you need for an IBS or RPR prepared just for you. Simply fax your name and birthday (same for your spouse if you're married), address and phone numbers (work, home and cell) to Irv Blackman at (847) 674-5299. Or email the info to irv@irvblackman.com. Mark "IBS" or "RPR" (or both) at the top of the page.



IRVING L. BLACKMAN has been practicing accounting and law more than 50 years, specializing in wealth transfer, business succession and valuation. He was a founding partner of Blackman Kllick Bartelstein LLP, CPAs, one of the largest accounting firms in the country, and is a member of the Illinois Society of CPAs, American Institute of CPAs and the American Speakers Association, among other organizations. Blackman has authored 21 books on taxation and penned hundreds of articles for trade publications. His company, Tax Secrets of the Wealthy, is headquartered in Naples, FL. He may be contacted at (847) 674-5295 or Irv@IrvBlackman.com.


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