Affordable captive insurance company (CIC) solutions
By Roccy Defrancesco
The Wealth Preservation Institute
What’s the number one complaint from profitable small business owners? They pay too much in income taxes — and this is only going to get worse in 2011 and beyond. What are the options to help reduce income taxes for business owners?
1. 401(k)/profit sharing plans — Low deductions, EE inclusion and income taxable distributions.
2. Defined benefit plans — Deductions can be substantial for older clients, EE inclusion and taxable distributions.
3. Section 79 plans — To put it bluntly, they are not financially viable.
4. Captive insurance Companies (CIC) — A risk management tool where deductions can be substantial, no EE inclusion, long term capital gains taxes due upon termination.
A CIC is an insurance company established to insure the risks of its parent company or a group of companies. In the simplest form, a CIC is an organized plan of self-insurance that calculates risk, issues policies, collects premiums, pays expenses and establishes reserves to pay future claims. This article discusses CICs formed under 28 U.S.C. sec. 831(b).
Why are captives formed?
Captives are formed for several reasons, which include, but are not limited to:
1. To protect against liabilities not covered by the traditional insurance
2. To control risk by setting coverages desired by the business owner
3. To provide greater control over claims
4. To reduce total insurance costs
5. To assist in income tax planning
6. To provide wealth building inside the CIC
7. To help provide estate planning for business owners
8. To help provide asset protection
Premiums paid to a CIC are 100 percent tax deductible under code section 162 as ordinary and necessary business expenses to the business paying for insurance coverage, and are tax free to the CIC receiving them. Investment growth inside the CIC is taxed at the C-Corporation tax rate.
How do you mitigate the taxes levied on reserves at they grow in the CIC?
The CIC owner can have the reserves allocated to tax-free bonds, tax-efficient brokerage accounts or cash value life insurance.
What happens after years of funding a CIC when the owner decides it is no longer needed?
When a CIC is closed down or when an owner has an interest redeemed, the owner would pay long term capital gains taxes on the above-basis assets of the CIC.
Does a CIC bear 100 percent of the risk for the insurance coverage it provides?
No. Conservatively structured CICs share 50 percent or more of their risk with other similarly structured CICs. CICs are real live insurance companies that issue policies to policyholders who can have claims. A good CIC structure will share risk with a large risk pool to spread the risk among other CICs.
Who has control of the money in a CIC?
Captive owners control their company, how claims are handled, and how reserves or underwriting profits are invested. Accounts are set up so that the CIC owner has total control of the money.
A new affordable CIC solution
A typical CIC costs $50,000–$75,000 to set up and $35,000–$50,000+ a year to run, which is why it’s not viable for most clients. Because of the typical setup costs, clients need to be able to pay premiums of $400,000 or more a year, which narrows the market of clients who can use the typical CIC structure.
The affordable CIC charges only a $5,750 setup fee for every $100,000 in premium, and an annual fee of only 11 percent on new premiums every year.
What does this new price structure mean?
It means that the structure is designed for clients who want to use a CIC where the minimum premium will be $100,000. This price point will make CICs available to many small business owners who are not candidates for the typical CIC structure.
The question for your profitable business clients:
Would you rather take $100,000 home and pay income taxes on it? Or would you rather mitigate uninsured risk in your business and build wealth by paying a $100,000+ deductible insurance expense to a CIC you own? And when the time comes to close the CIC down, the money remaining will come out at a long-term capital gains rate.
Most will opt for the latter and now, with the affordable CIC structure, you can bring clients a solution that before was only affordable to clients who could pay premiums of $400,000 a year or more.
Cash-value life insurance
As stated above, one way to mitigate income taxes paid on investment gains in a CIC is to use cash value life insurance. In the affordable CIC structure, owners will be able to allocate 50 percent to 75 percent of their available assets to cash value life insurance. In addition to tax mitigation, using cash value life insurance in a CIC also helps owners protect their reserves from downturns in the stock market.