Episode B examines when a qualified plan is used not for retirement planning, but for business planning. How can a qualified plan be used with a buy-sell agreement, or with succession planning? We break it down for you, to give you the gist without being overwhelmed.
Episode B examines when a qualified plan is used not for retirement planning, but for business planning. How can a qualified plan be used with a buy-sell agreement, or with succession planning? We break it down for you, to give you the gist without being overwhelmed.
For Episode B: Business Planning. When is a qualified plan NOT a qualified plan? When it’s being used for business planning needs, such as succession planning and buy/sells. We’re going to cover QPs, and then succession planning and buy/sells, and see how they can come together to pay for business planning needs with pre-tax dollars. How does this work? Let’s talk it through.
· In general – QPs have to benefit both the owners and employees
· Part of the tests we have to do to make sure its “qualified” – can’t give too much to the owner, can’t give too little to the EEs.
· Typical plan, 80-90% or more of the benefit going to the owner
· Talk about buysell first –
· FUN FACT – a buy sell agreement has nothing to do with buying or selling a company. Of course it doesn’t .. that would be too easy, right?
· Per Wikipedia, A buy–sell agreement, also known as a buyout agreement, is a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business. Generally, the business puts insurance on partners or co-owners, with the beneficiaries being other partners or the business. If a partner passes away, the spouse usually gets the shares of the business, whether they want it or not, and the business gets the insurance payment. The business can then use the insurance to buy the shares back from the spouse – essentially spouse gets $, the other partners/business get the shares back.
· How would QP be used for this? Well, ins can be used as one of the investments in a plan, as long as it is used for all ptps and as long as you don’t use too much. If partners are getting large benefit, portion of that contribution can buy LI – to be used for a buy sell. Take an example – say there are 3 partners, and put in a plan so that each partner is getting contrib of $200k into a pension plan. The plan could use 30% of the contribution, or $60k per partner, as premiums to buy insurance. That may cover $750k-$1M in death benefits for those partners – and remember, this is coming from plan contributions, which are deductible to the business. See where I’m going? If each partner needs $3M in insurance, you may be able to get $1M for each in the plan, paid for pre-tax, and the rest outside the plan on an after tax basis. You’d have 2 policies, sure – but you just saved around $100k in taxes with those premiums, by paying the $60k out of the plan for the 3 of them. Why pay after tax when you don’t have to?
· Rest of assets NOT used for ins would be in general investments – usually see annuities, mutual funds, things like that.
· Move to succession planning.
· Most owners would love for their children to take over the business. I can tell you that there’s no way in heck either of my boys are on that track – here’s a fun fact:
· Most family business owners have heard these statistics: 30% of family businesses make it to the second generation and only 13% make it to the third generation.
· So I need a plan B – namely, to bring someone in and keep them here until I retire. Let’s use myself as an example – I own Monarch, and I hire a younger version of myself to take over biz when I retire. Lou Murnett – instead of Sue Burnett – get it? Things are going great, Lou is doing well, and I’m expecting to sell her the business in 5 years. But … I see that she’s not really saving, and I’m hoping to get $1M for Monarch. If she could put away $150k per year, that would come really close – but with all her vacations, and fancy cars, I don’t think that’s going to happen, and I’m never going to retire.
· How can a QP help? Well, let’s say I set up a QP maximizing payments for me, and I know I can contribute $150k per year for Lou. I show Lou 2 summaries – one showing $150k going into the plan for her, resulting in almost $800k in 5 years. She really likes that. Then I hand her another stack of papers – there’s a summary showing NO contribution going in for her, as well as a legal document saying that I’ll credit the $800k that I WOULD have put in towards her purchase price in 5 years. This is amazing in lots of ways – for me, it keeps Lou here for 5 years, because she’ll have an $800k credit towards buying my business. So it’s a retention tool. Also for her, she never actually had the $ in her pocket anyways – so it’s money that she’s credited that she never actually had. And me? I keep the $150k per year that I would’ve given to her, maybe put a little more in for myself … either way, the money is going into my pocket, not hers. It’s forced savings towards my end game of retirement.
· Wrapping it all up – qual plans are great to save for retirement and to give owners tax deductions. But when is a QP not used for a QP? When they’re used for business planning.
· They can be used to fund buy-sell insurance pre-tax by using insurance as an investment in the plan. They can also be designed for succession planning, zeroing out Lou’s benefit in the plan and using it as a credit for her in the future – this helps her stay with me until retirement. How much can be used? That’s what we’re here for – we can get you up to the limit, so you can be sure to maximize the use of your plan
· FINAL FUN FACT: Empires, monarchies, and dynasties, like businesses, usually look to pass ownership to succeeding generations. Some, like the Roman Empire and British monarchy, are way more successful than others. The prize for the shortest reign goes to Louis-Antoine of France – he reigned for a whole 20 minutes before abdicating. And my guess is that he didn’t have time to put a succession plan in place.
· Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.