Why Ultra-High-Net-Worth Clients Should Consider 831(b) Plans

Hurricane Rita caused extensive flooding in Hoboken, New Jersey, in 2011.

Experts found there were about 2,756 investment advisors managing $1 billion to $5 billion in assets in 2022. Many of these advisors likely specialized in working with ultra-high net worth clientele.

Even more than other clients, UHNW clients face exposure to market volatility, liquidity management challenges, and potential litigation.

An advisor's job is to help identify exposure and risk to develop a comprehensive plan to ensure their clients' assets are protected.

One risk-mitigation tool that is gaining increasing traction is the 831(b) plan, a relatively unknown but impactful part of the U.S. tax code. It was created to help business owners set aside tax-deferred funds for risks that traditional insurance may not cover.

This risk-mitigation strategy is used by nearly every Fortune 500 company and is ideal for mitigating UHNW client business risks as well.

It puts the power of having control of risk-mitigation back in the hands of the insureds, rather than the insurance companies.

Have you noticed that insurance policies are getting thicker? It's not because insurers are adding coverages, but rather adding exclusions for what they won't cover all while charging more in premium.

Understanding 831(b) Plans

Also referred to as micro captive insurance, 831(b) plans were first introduced in 1986 under section 831(b) of the Internal Revenue Code.

Much like the 401(k) tax code allows an employer to set aside tax-deferred dollars for retirement, the 831(b) tax code allows a business to set aside tax-deferred dollars to cover under or uninsured risks.

By setting aside these tax-deferred funds, businesses can even out the peaks and valleys of risk more efficiently.

This form of self-insurance and risk management is vital in a world where ample insurance and risk protection seem to be dwindling by the day.

It really puts control back in the hands of small to mid-size business owners and high net worth clients.

Consider the events during and after the COVID-19 pandemic hit its peak.

As a nation, we saw many businesses close their doors.

Of those that stayed open despite a drop in sales, many had a contingency plan. One of the most efficient risk-mitigation solutions was by using the 831(b) tax code.

Businesses that already had an 831(b) plan in place were able to file a claim and draw on their plan reserves quickly to keep going until things returned to normal.

Essentially, they became their own self-reliant Paycheck Protection Program.

One of our clients — let's call him "Dave" — was a real estate developer who found himself struggling due to the supply chain interruptions as a result of COVID-19.

These interruptions looked like factory shutdowns and shipping containers stuck in the harbor, which resulted in him having to source and repurchase materials elsewhere at a higher cost due to increased demand and quick delivery requirements.

However, Dave had already been participating in his 831(b) plan for two years when the pandemic hit, so he was able to use the 831(b) to pay the extra costs of materials and keep the project on track while waiting out the pandemic long before any PPP plan was launched.

Other high-net-worth individuals can employ similar tactics when it comes to wealth management.

These individuals will want to protect their assets through the usage of a legal framework, which is when an 831(b) plan comes into play.

Choices

According to the tax code, the owner of the 831(b) plan is owned by the business owner(s) — this includes everything from underwriting, policy investments, claims decisions, and more — thus allowing for greater control over risk-mitigation and business protection.

After one year of holding a micro captive policy, clients with micro captives have many more options than clients using traditional insurance.

If clients with micro captives have a surplus and the insured's claims are less than the premium that year, they can choose to keep their money invested as it is currently or can choose to take a more aggressive approach.

They can also take out the money as a qualified dividend at long-term capital gains; or loan themselves a portion of those funds.

Where to Start

First, what are your clients' risks?

This is a question we have always recommended advisors ask when deciding whether the usage of an 831(b) plan is right for their clients.

Advisors must consider the unfunded liabilities of their clients, such as brand reputation, sub-limits on natural disaster insurance, or exclusions in cybersecurity policies.

These high-severity, low-frequency events could leave a business paying debilitating sums out of pocket.

Second, what do you know, and are you working with experienced, reputable micro captive specialists?

It is imperative advisors with UHNW clients understand the basics of the 831(b) Tax Code before suggesting it as a risk-mitigation tool.

Now more than ever, small to mid-size business owners and high-net-worth clients want more control over mitigating their risks.

Thanks to the increased risk-mitigation safety net created by an 831(b) plan, and the ability to tailor these plans to each individual or business's needs, advisors should consider this as a solid tool to ensure their clients can weather the storm no matter what risks come their way.

Credit: Allison Bell/ALM

Van Carlson is the founder and chief executive officer of SRA 831(b) Admin, an Eagle, Idaho-based firm that helps high-net-worth clients with risk-mitigation arrangements.