IRA BAILOUT PLAN
If you have more than $1MM in an IRA plan... and if you have accumulated enough wealth in other assets and you're not going to use your IRA funds to fund your own retirement... when your kids inherit your IRA, they will pay both income taxes and estate taxes. In the state of California, that is over 70% in tax erosion. Watch this video to learn how our IRA Bailout Plan can provide a better solution.
We sat down with Darren Sugiyama – Founder & CEO of Lionsmark Capital – to talk about how he uses Premium Financed Life Insurance in estate tax planning, specifically regarding large IRAs.
Most wealthy individuals with $1MM+ IRAs will consider a Roth Conversion, however Darren Sugiyama explains there is a more tax-efficient option that could result in more than double the value inherited by generation two.
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Question (Q): A lot has changed in the estate planning area in recent years. What are you finding in this space that seems to be the most challenging for high net worth individuals.
Darren Sugiyama (DS): I would say clients with large IRAs – you know, IRAs over $1,000,000 – that have net worth amounts large enough to trigger 40% in estate taxes… these clients’ kids are going to get double taxed on these funds when they inherit their parents’ IRAs. So we developed platform that uses some pretty sophisticated estate planning methods that repurposes those IRA funds in a much more tax-efficient way. It’s called the IRA Bailout Plan.
Q: What is the IRA Bailout Plan and who can benefit from this strategy?
DS: It’s a strategy for wealthy individuals – typically $20 million net worth amounts and up - that have a substantial IRA, and they’ve built up enough wealth in other assets where they really don’t need their IRA funds for their own retirement, so they’re planning on just passing their IRA on to their adult kids at their end-of-life. The problem is their kids are going to get double taxed on these funds, which in California, could make them lose over 70% of the IRA value when they inherit this asset. Even for clients that live in the state of Florida or Texas where there’s no state income tax, the total tax erosion on IRAs can be as much as 62.20%. So we have a solution for that, which is the IRA Bailout Plan.
Q: So let’s start off with the basics. What exactly is an IRA?
DS: Well, an IRA is an Individual Retirement Account, and most wealthy individuals that have a large IRA are folks that had some sort of pre-tax retirement account – like a 401(k) for example – that was funded with pre-tax dollars, and when they were done working for their employer, they rolled their 401(k) into an IRA, which has the same tax treatment as a 401(k), right… tax deferred growth, but 100% taxable on the way out. Now, the benefit – or I should say the perceived benefit – is that by contributing pre-tax dollars, you have the benefit of compound interest working in your favor, as opposed to contributing the smaller after-tax equivalent.
Q: Well, isn’t that true?
DS: In theory, it makes sense on the surface, but it always cracks me up when someone says, “Oh, my IRA is worth $X,” because that’s not all THEIR money. A good chunk of that belongs to Uncle Sam. And if they’re wealthy enough where their net worth is above the estate tax threshold, not only is their IRA going to be subject to income taxes, but it’s also subject to ESTATE taxes, which is currently 40%.
Q: So for people in a high tax bracket, it sounds like the whole “contribute pre-tax dollars” theory might not always ring true. Is that a fair statement?
DS: Well, that’s why a lot of wealthy people are encouraged to roll their traditional IRA funds into a Roth IRA, known as a Roth Conversion.
Q: I’ve heard of Roth Conversions. What exactly is a Roth Conversion, and does it make more sense for someone that has a large Traditional IRA?
DS: Well, it depends on the client. Like for example, if they really aren’t going to use their IRA funds for their own retirement, the downside of leaving the funds in the traditional IRA is that they WILL be subject to RMDs, right… the Required Minimum Distributions Uncle Sam makes you drawdown from your IRA starting at age 72, and come the year 2032, that age gets pushed back to age 75. But again, for people that don’t need these distributions for their own retirement, that’s part of where a Roth Conversion comes in. If they convert to a Roth, they have to pay income taxes on the full amount they convert immediately, however the nice thing is that Roth IRAs are not subject to RMDs, so the client can just let those funds grow tax-free from that point moving forward because they paid the income tax on the amount they converted, AND they don’t have to take RMDs, which can increase the amount their kids inherit.
Q: So how would a client know which one is better for their unique circumstance – their Traditional IRA versus doing a Roth Conversion?
DS: That’s where our firm comes in and does the analysis, from a mathematical perspective. In most cases, for high income and high net worth individuals, the Roth Conversion makes more sense than just leaving the funds in the traditional IRA.
Q: Okay, I understand the idea that it might make more sense to pay the taxes now in the Roth Conversion so you don’t have to take RMDs, but isn’t the Roth still subject to the 40% in estate taxes?
DS: Well, that’s the problem, which is where our IRA Bailout Plan comes in. In this scenario, our clients will roll their IRA funds into a profit sharing plan, which buys a life insurance policy inside the plan.
Q: Interesting. Okay, so how is the profit sharing plan established? Does the client need to have an active income-producing company to sponsor the profit sharing plan?
DS: If they have an existing company, they could use that entity to be the plan sponsor, however for liability purposes, it’s typically better to set up a new special purpose LLC, of which the married couple are the only members of the LLC. That way, they don’t have to include any other employees in the profit sharing plan.
Q: But what about affiliated services and discrimination testing? Aren’t they required to offer a profit sharing plan to their employees in their other company?
DS: Great question. If the new LLC provided similar business services OR related business services to their current company, that would not pass the smell test. However, if the new business entity – in this case the LLC – had a legitimate business purpose that was completely unrelated to any existing business, then it’s a non-issue. So in most cases, the business purpose of the newly formed LLC will be to manage the family’s wealth, kind of like a Family Office. The married couple will be the only members of the LLC, and we would put them on a legitimate W-2 employee payroll for a nominal amount… and then the business would be the plan sponsor of the Profit Sharing Plan.
Q: So once the new LLC is set up and payroll is established, you then set up the Profit Sharing Plan?
DS: Correct. An attorney drafts the plan document, which usually costs around $1,600, and a TPA administers the Profit Sharing Plan to keep in in compliance, which is typically about $2,500 per year to administrate (a nominal amount), and then the client rolls over their IRA funds into their individualized Profit Sharing Plan allocations.
Q: And what’s the tax consequence at that point?
DS: Nothing at this point. It’s similar to rolling a 401(k) into an IRA. We’re just rolling the IRA funds into the client’s Profit Sharing Plan – one qualified fund into another qualified fund, so no taxes due at that juncture.
Q: Okay, so when does the life insurance component enter the picture?
DS: So once the PSP (Profit Sharing Plan) is established and funded, the client will purchase a life insurance policy INSIDE the PSP using those pre-tax dollars. So as an example, let’s say the IRA value was $4 million. We would use that $4 million to fund four years of $1 million premiums into the life insurance policy. Then after four years, the client would use an ILIT (Irrevocable Life Insurance Trust) to buy the policy out of the Profit Sharing Plan.
Q: And what is the purpose of buying the policy out of the Profit Sharing Plan?
DS: Well the nice thing about the ILIT is that it sits OUTSIDE the client’s taxable estate. So the client gifts some funds to the ILIT – which would use up some of their unified credits under the gifting exemption – and the ILIT would buy the policy. Now the policy is owned by the ILIT, outside the taxable estate, and the purchase amount – goes right into the Profit Sharing Plan. But a big benefit of this transaction is that the policy’s true “value” is less than the premiums paid, so the buyout is at a deep discount.
Q: So what exactly does that mean when you say “discount?”
DS: Okay, so the value of a life insurance policy can be determined at any time, and there’s more than one way to determine the valuation. One way is to have a third party valuation firm estimate the fair market value which is somewhat subjective and debatable, so we don’t use that method. Another way to do it is what they call this the ITR (Interpolated Terminal Reserve) which is determined by the carrier, however this method of valuation is under scrutiny, so we don’t use that one either. The third way to do it is known as the PERC value. This is a calculation of the premiums paid, PLUS the earnings on cash value, minus reasonable charges. So to be conservative, we use the IRS Safe Harbor Valuation under Rev Proc 2020-25. This is an indisputable valuation and the most conservative way to do it. You see, the thing to understand about life insurance policies is that the majority of charges are in the first several years of the policy, so if you buy a $20 million life insurance policy, and you pay a million dollars of annual premium for four years, the cash value – depending on the policy design – might only be 40 to 80% of the premiums paid, so we’re talking about getting a 20 to 60% discount, which is hugely advantageous for the client.
Q: Okay, so now the policy is owned in the ILIT, outside the taxable estate. Then what?
DS: So usually in the 6th year, we’ll inject one more premium into the policy, however we’ll use a bank’s capital to pay the additional premium, and we’ll use the remaining amount that’s still in the Profit Sharing Plan to pay the interest-only payments each year to the bank. This is called Premium Financing.
Q: We know that you’re kind of THE premier premium financier in the country when it comes to extremely large life insurance policies. In fact, you’ve written several books on this topic, correct?
DS: I have. In fact I’ve published 11 books in my career… three of them specifically about premium financing. They’re all on Amazon, and the most recent one I put out in January of 2024.
Q: And what is that one called, so our listeners can pick that up on Amazon?
DS: It’s called Premium Financed Life Insurance – The Key To Effective Estate Tax Planning, and it’s the 2024 Edition. The version prior to this one, I put out in 2021, and as you know, the landscape in my space evolves very quickly, so I’ve decided to put out a new edition at the beginning of each year, you know an updated version so the content is always current and relevant.
Q: Wow, that sounds like a lot of work!
DS: I know! Sometimes I think I must be some kind of a masochist or something. <laughs>
Q: So how many books have you published in your illustrious career?
DS: I’ve published 11 books in my career… three of them specifically on premium financed life insurance.
Q: And you have international distribution as well, correct?
DS: Yeah, I’m in fourteen different countries in addition to the U.S. In fact I just got word from my distributor last week that my Premium Financed Life Insurance book was just released in China, Czech Republic, Denmark, Italy, and Poland.
Q: Wow, that’s incredible. Congratulations!
DS: Thank you. That’s really kind of you to say.
Q: So when someone uses your IRA Bailout Plan, how much additional benefit do they really get in comparison to a traditional IRA or a Roth Conversion?
DS: Well, as an example, I just ran a case on a married couple. Husband is 66 years old and the wife is 59. $4MM IRA. We used a survivorship policy, which means the insurance policy is on both the husband and the wife, and pays out at the death of the second spouse… so if the husband predeceases the wife - which is what usually happens - and the wife dies at say age 88 (which would be 30 years from now), their adult kids would get $21MM tax-free using the IRA Bailout Plan, versus only netting $8.2MM in a traditional IRA plan, so we’re talking about a 2.5X increase. Two and a half times more!
Q: Wow, more than double the outcome?
DS: Yeah, it’s pretty substantial.
Q: Okay, so why wouldn’t EVERYONE do this?
DS: Well, again, it depends on the client’s unique situation. For example, if you have a client that “thinks” they won’t need any of their IRA funds to retire on, but they “might” need them because they don’t have a high enough net worth outside of their IRA to live on, then they shouldn’t do this. It’s ONLY for folks that KNOW they’ll never need their IRA funds, and their kids are just going to inherit the IRA, and they’re going to get double taxed.
Q: Okay, who else is not right for the IRA Bailout Plan?
DS: If the client is over 80 years old, or if they’re too unhealthy, the cost of the life insurance may not justify the return, and we run the analytics for every client to make sure the math plays to their advantage. If it doesn’t I’ll be the first one to say, “Hey, this is not for you.”
Q: Anyone else who you think this is not suitable for?
DS: I mean not really. If the client is sure they won’t need their IRA funds for their own retirement, and they just want to max out what goes to generation two… and if they’re under age 80 and reasonably healthy, it’s kind of a no brainer.
Q: Is there anyone else in this space at the moment?
DS: Sure, there are several firms out there that do this kind of planning. It’s not really a unique structure, but what’s unique about my platform is that it incorporates premium financing, which is my specialty. I’ve kind of build a reputation of being the most transparent premium financing specialist in the life insurance industry, so this component is something that no other IRA rollover firm has. Plus we have some really unique financing structures that are built to specifically address the needs of our clients. Eighteen different lenders. Several different TPA options. But the biggest part that really sets us apart is our client communication content. We create a custom video for each client where I’m personally walking them through their specific numbers. It’s really great from an educational perspective, and it also documents what we explicitly talked about. You know, the problem with any complex and sophisticated planning is that the client won’t likely remember all the details – simply because it’s a complex structure – so these custom videos allow them to re-watch the presentation, hit pause, rewind, and jot down notes/questions they can ask us on the next Zoom meeting.
Q: Well, okay. How can people find out more about the IRA Bailout Plan?
DS: I exclusively work with financial advisors, CPAs, and estate planning attorneys who send me their clients, so if you're a client who's reading this interview, contact the advisor that sent you to this site... and if you're an advisor, you can click on the button below "Request A Client Proposal" and fill out your client's basic info, and that will initiate a Zoom call with between the advisor, the client, and me to find out if this is appropriate for your client.