Retirement Planning for Small Businesses
One of the chief concerns of small business owners and professional practitioners is how to defer enough income to allow them to retire comfortably. Many are unable to make significant contributions to traditional retirement plans during their startup phase and need to find ways to make up for lost time once they get established. While there are many ways to do this, owners and principals of firms that carry a significant amount of receivables can often leverage this asset into a substantial retirement benefit.
Turning Receivables and Earnings into Savings
The idea of leveraging business receivables to generate retirement savings is not new, but many business owners don't know this strategy and its many potential benefits. Although the program can be structured in many ways, the core concept is fairly simple: The business owner applies for a loan – either directly to one or more lenders, or through an originator who applies on his/her behalf. The underwriting department will examine the financial statements of the borrower and the business (or both) to determine the feasibility and size of the loan.
Borrowers who are approved will then receive either a lump sum or a series of payments over a period of years. These funds typically must be used to purchase either a guaranteed annuity contract or a cash-value life insurance policy. In most cases, this vehicle must be guaranteed by the carrier, as it often serves as collateral for the loan. The borrower is usually required to repay the balance over a period of five to ten years. In other cases, the lender places a lien on the borrower’s business receivables or personal assets in order to secure the loan. Once the borrower has repaid the loan in full, the lien is released and the borrower assumes unconditional ownership of the policy or contract.
Advantages of Leveraged Benefits
The most obvious benefit leveraged programs provide is the ability to accumulate a substantial retirement benefit within just a few years. Because they are not qualified plans, most leveraged programs are structured to fund substantial contributions of tens or even hundreds of thousands of dollars, in either a single payment or series of payments. This effectively provides an avenue for high-income earners who will not be able to replace their current income in retirement with IRA or qualified plan distributions to continue their current lifestyles after they stop working.
How a Plan Could Work
Bob, Greg and Darlene run a thriving ophthalmology practice that provides each of them with an average annual income of about $500,000. Each is in their late 40s and makes the maximum possible contribution to a self-employed 401(k) plan. They have just paid off all of their business debts and are looking to make substantial additional retirement contributions. They set up a leveraged benefit program through one of their financial planners that will loan them each $500,000 in a lump-sum payment. Each of them uses the proceeds to purchase single premium indexed universal life policies with a death benefit of over $4 million. The lender places a lien on their receivables by filing form UCC-1 with the county and state. They will make monthly loan payments for ten years, after which the lien will be released. The cash values in their policies will provide additional tax-free retirement income for each of them.
In this case, the borrowers could also use the policies to structure a buy-sell agreement by designating each other as beneficiaries so that the survivor or survivors could use the death benefits to buy the deceased’s share of their practice.
Another key attribute of most leveraged benefits programs is that the loan often charges only simple interest, while the policy or contract provides compounded growth. And those who employ this program using their business can also usually deduct their loan payments as a business expense. And many programs now offer loans based upon other types of income than receivables, such as current income that is generated from a successful practice or business.
Who Can't Get One
Although leveraged benefits can provide a better rate of return than most other nonqualified plans, the best options are typically only available to those who are insurable. Clients with significant health issues may only be issued a small policy or be required to pay a great deal more for sufficient coverage. Those who are uninsurable can use an annuity contract in lieu of insurance, but this income will taxable when it is withdrawn. Another factor to consider: The receivables used as collateral in these programs cannot be used in any other way until the loan has been repaid – although this rarely a significant issue, as the lien used for these loans typically has minimal impact on the borrower’s credit score.
Where to go
Many financial planners and insurance agencies market leveraged benefit programs to business owners. They provide the insurance products while lenders such as BNY Mellon Bank make loans, either directly or through an originator. Some firms, such as Global One Financial and First Insurance Funding, offer complete turnkey packages that are created and managed in house. Eric Stein, senior vice-president of marketing for Entaire Global Companies, Inc., estimates that his firm will probably finance about $200-250 million worth of premiums in 2014. “Our market segment has continued to grow in this area, and we can even refinance previously leveraged customers in many cases. The leveraged programs that are offered today are more flexible and competitive than ever, and many providers can now also service high-income individuals who qualify as accredited investors.”
The Bottom Line
The leveraged benefits market will likely continue to expand for the foreseeable future as wealthy clients continue to seek new ways to provide secure retirement income for themselves. Although this strategy is not appropriate for everyone, those who qualify can receive a substantial retirement benefit with a potential tax deduction that falls outside the jurisdiction of ERISA guidelines. For more information on leveraged benefits, consult your insurance broker or financial advisor.