The following illustrates a common tax planning scenario for high net worth clients and an insurance-based solution for satisfying their goals.
Will and Sarah Wald have focused on careers and family for most of their lives and now find themselves in a comfortable stratum of the marketplace. They acknowledge that paying estate tax is a given and they want to alleviate tax issues on current and future income.
Paula Producer was conducting a non-qualified deferred compensation plan review at Horizons Architectural when she met Will Wald, a senior architect at the firm. Will deferred his bonuses for 16 years, matched at 50% by the firm, and had looked forward to enjoying the significant retirement income he would eventually receive.
He retired last year and he and Sarah are now contemplating the income tax burden they will face, on income they neither need nor want, when his distributions begin. Will talked with Paula about their dilemma. She suggested they meet with his lawyer and CPA to discuss an exit strategy.
With Will's deferrals and the employer match, his account is valued at more than $7,500,000, which will fund annual payments of $500,000 for 15 years. If Will dies during the term, his family will receive the balance of his deferral account, but the employer match will cease.
First things first
Paula focused on the terms of the employer match ceasing if Will dies during the distribution period. At a 50% match, significant wealth for his heirs could be lost. She noted that Will deferred his bonuses for years in anticipation of the employer match, accumulating greater wealth for himself and his family.
The fact that he and Sarah no longer need the income generated by his NQDC plan should not keep him from taking steps to preserve as much of the wealth as possible for his heirs. Paula suggested that Will use a portion of each distribution to fund, in their irrevocable trust, a life insurance policy on his life to replace the lost benefits if he dies prematurely. Will and Sarah agreed that he will set aside $70,000 a year to fund a $3 million policy, and pay income tax on it each year.
Counter-intuitive planning
Next, Paula proposed that Will gift his remaining distribution of $430,000 each year to charity, to provide him with an annual charitable income tax deduction to offset the receipt of the distribution. Neither Will nor Sarah was interested.
They have long believed that charity begins and ends at home. Paula asked them to be openminded, as she explained how other clients created and preserved generational wealth for their families, often with little or no taxation, by including charities in their estate plans.
