Climbing the Pyramid for More Tax-Efficient Lifetime Income

death benefit for his or her heirs that may be more than $1,000,0003. Visit our website for more information about this topic.

About the Author

Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www.

ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.

Level 6: Creative planners continue to find synergistic combinations of planning instruments that can provide benefits that exceed those illustrated in Level 5.

For example, the Family Retirement Account™ (“FRA”) leverages the benefits of universal life insurance using loans and a dynasty trust in order to convert taxable retirement income into tax-free cash flow and/or wealth transfers.

Capital Split Dollar (“CSD”) helps employers take income tax deductions for funding tax-free retirement and death benefits for key executives. While qualified attorneys opine that the FRA and CSD are within the letter and spirit of the tax code, the techniques may be too complicated for some clients. A simpler alternative may be the charitable LLC. $500,000 contributed can produce more than $2,000,000 for family and charity. The family benefits can exceed those of the Section 79 plan while also giving your client the satisfaction of redirecting tax money to their favorite charities.

Conclusion New tax laws, such as the 409(A) rules passed several years ago and the American Tax Relief Act signed this year, have curtailed many popular planning strategies. Wise planners, like Hercules, find that each time a head is cut off the hydra, two new heads grow. The decline in the demand for estate tax business is small compared to the big increase in the demand for income planning and retirement planning. Financial planners have immense opportunities to serve the tens of millions of clients who are stuck at level 1 or level 2 of the above pyramid. As indicated above, there are compelling reasons and great financial rewards for the clients who advance to levels 3, 4, 5 and 6 in the tax efficient lifetime income planning process.

1 http://vfos.com/webdocs/2013CaliforniaRates.pdf 2 The Federal capital gains rate is 20%. As noted in the above footnote, the California tax of 10.23% applies to married wage earners with only $97,884 of income in 2013.

3 http://vfos.com/webdocs/M45_SampleSection79.pdf

Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com

Climbing the Pyramid for More Tax-Efficient Lifetime Income Key Takeaways

New tax rules have created immense opportunities for savvy advisers

• Tens of millions of taxpayers who never had much concern about the high marginal estate tax rates are now very concerned about the new high marginal income tax rates.

by Tim Voorhees

• Most taxpayers who now have higher income taxes continue to pay unnecessary income taxes on their retirement plan contributions, accumulation, and/or withdrawals.

• Financial planners can help prospects and clients minimize income taxes by climbing up a “tax efficiency” pyramid that has progressively more powerful strategies the higher up you go.

• The most powerful income tax strategies are often funded with life insurance.

Impact of Investing Excess Income Tax Efficiently: With Tax-Efficient Planning Tools If 50% of Excess Income Lost to Taxes BeforeInvesting: If Investment Returns are Reduced by 38% Taxes:

Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein.

If 38% of Accumulated Value Lost to Withdrawal Taxes

Opportunities for financial planners increased dramatically in early January when the President signed the American Tax Relief Act of 2012 into law.

While the demand for estate planning shrank when the estate and gift tax exemption increased from $1 million per person to the new “permanent” exemption of $5.25 million per individual, the need for income tax planning grew substantially when the top marginal rates increased for most taxpayers.

Many clients will now have top tax rates of more than 35 percent on capital gains and more than 50 percent on ordinary income unless financial planners provide solutions.

The impact of the new higher tax rates is evident when projecting retirement savings growth over 20 years. For example, a business owner funding a retirement plan with $500,000 over the next few years can expect the plan to generate more than $1,760,000 of tax-free income—if money grows at 6.5 percent and there are no taxes on contributions or withdrawals. If, however, the executive is married with income of more than $450,000, marginal tax rates may be 39.6 percent at the federal level and 10.23 percent at the state level1. Our website has more information about this topic.

Together, these taxes reduce money going into Roth IRAs, retirement annuities, and related retirement investments by almost 50 percent. If the executive 20 Years at 30 Years at keeps the money in annuities or stock Now investments, there will likely be additional 6.5% 8% taxes when the funds are withdrawn. $500,000 $1,761,823 $5,031,328 Even if the taxes are at capital gains rates instead of at ordinary income rates on $250,000 $880,911 $2,515,664 withdrawals, the capital gains rate is now 34 percent for some people earning less $250,000 $580,265 $1,068,205 than $100,0002. This is because the Federal capital gains rate is 20 percent, and the N/A $359,764 $662,287 California tax of 10.23 percent applies to married wage earners with only $97,884 of income in 2013. If income is more than $250,000 for a married couple, there may be a 3.8 percent surtax as well, thereby raising the capital gains rate to about 38 percent. If the 50 percent

As long as clients are willing to make longer-term investments and properly integrate planning instruments, they can climb the pyramid of taxefficient retirement planning.

rate on contributions applies along with the 38 percent rate on withdrawal, the $500,000 grows to only $546,165 over 20 years. Obviously, taxes reduce retirement income to less than one third of what it could be over 20 years. The impact is even more dramatic at higher rates of return or over longer periods of time, as shown in this table: Obviously, retirement plans will perform better if there are no taxes on the contributions, accumulation, and withdrawals. Fortunately, American tax policy encourages the pre-tax funding of investments in employees’ retirement accounts. Moreover, taw laws allow for the integration of legal, investment, and insurance tools to facilitate tax-free retirement accumulation and distributions.

As long as clients are willing to make longer-term investments and properly integrate planning instruments, they can climb the pyramid of tax-efficient retirement planning.

Sorting through the different tax planning options may seem like a herculean task; however, the diagram below simplifies the decision process. The six levels of the pyramid graphic illustrate how clients are rewarded for advancing from traditional to more innovative strategies.

Level 1: The bottom level on the pyramid depicts how most of your clients receive their income. Their paychecks show heavy FICA, FUTA, SUTA, and other payroll

Climbing the Pyramid Enhances Tax Efficiency Taxes on Employee Withdrawals

Taxes on Contributions Minimal Tax on Contributions

6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account

Minimal Withdrawal Taxes

Moderate Tax on Contributions

5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan

Moderate Withdrawal Taxes

Moderate Tax on Contributions

4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund

Moderate Withdrawal Taxes

Moderate Tax on Contributions

3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp

Heavy Deferred Income Tax

Heavy Current Income Tax

2) Qualified Plans Profit Sharing Defined Benefit 401(K) 1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

taxes as well as withholdings for state and federal taxes. As indicated on many pay stubs, more than half of the income can be lost to taxes at level 1. Moreover, after-tax investments in retirement vehicles can trigger additional taxes, as indicated on the right side of the pyramid below and in the after-tax numbers on the above table. Obviously, clients need to find more tax-wise solutions!

The tax-deferred growth in retirement plans has helped Americans accumulate more than $12 trillion in employee-based defined benefit and defined contribution plans.

Level 2: Climbing the pyramid to level 2 affords your client opportunities to invest in ERISA qualified plans. Such plans include 401(k) plans as well 403(b)s, SIMPLE plans, profit-sharing plans and defined benefit plans. While employee deferrals used to fund qualified plans will still be subject to payroll taxes, the heavy state and federal income taxes are deferred until money comes out of the qualified plans. The tax-deferred growth in retirement plans has helped Americans accumulate more than $12 trillion in employee-based defined benefit and defined contribution plans. Without additional planning, this $12 trillion is all subject to ordinary income taxes during retirement or at death.

Level 3: Business owners and highly compensated employees often want more tax benefits than qualified plans afford. Too often, the top-heavy rules limit the amount of contributions by highly compensated executives. To work around the ERISA restrictions, financial planners offer a variety of non-qualified deferred compensation plans. These include traditional deferred compensation plans involving salary and bonus deferrals as well as more sophisticated plans covered by 409(A) rules on deferred compensation. Since 2004, however, the 409(A) regulations have increased the risk of current taxes applying to non-qualified deferred compensation plans, including restricted stock, phantom stock and performance share plans, as well as stock appreciation rights and long-term year bonus or commission programs. To minimize the risk of current taxes while accumulating maximum amounts, a variety of supplemental executive retirement plans (SERPs) have been used by executives to accumulate substantial balances. Now these executives face much higher than expected taxes on their withdrawals because of the higher marginal rates in 2013. This is spurring growing interest in Levels 4 through 6 of the pyramid.

Level 4: The Level 4 solutions include a variety of charitable planning instruments that allow for large income tax deductions when they are funded as well as tax-deferred growth on the plan balances. Moreover, the distributions may have only moderate withdrawal taxes. For example, charitable remainder trusts (CRTs) can distribute tax free or capital gains income. Gift annuities can pay out partially tax free income by returning the initial investment capital as part of each payment. These charitable tools can be customdesigned for each individual to start retirement income when income is most needed or tax rates are lowest. For these reasons, the charitable tools at level 4 can provide better bottom line benefits than those generated at levels 1–3.

Level 5: Clients focused on retirement security and income may reject level 4 solutions because “charity begins at home.” Fortunately, there are charitable solutions, such as a Super CLAT designed with the current low 7520 rate that can increase what goes to the donor throughout retirement. For substantial benefits from non-charitable tools, employers will often take deductions for a Section 162 plan or a Section 79 plan. For example, a company can make pre-tax contributions of $500,000 to a Section 79 plan so that an employee can receive tax-free income of nearly $1.1 million while also funding a tax-free

As long as clients are willing to make longer-term investments and properly integrate planning instruments, they can climb the pyramid of taxefficient retirement planning.

rate on contributions applies along with the 38 percent rate on withdrawal, the $500,000 grows to only $546,165 over 20 years. Obviously, taxes reduce retirement income to less than one third of what it could be over 20 years. The impact is even more dramatic at higher rates of return or over longer periods of time, as shown in this table: Obviously, retirement plans will perform better if there are no taxes on the contributions, accumulation, and withdrawals. Fortunately, American tax policy encourages the pre-tax funding of investments in employees’ retirement accounts. Moreover, taw laws allow for the integration of legal, investment, and insurance tools to facilitate tax-free retirement accumulation and distributions.

As long as clients are willing to make longer-term investments and properly integrate planning instruments, they can climb the pyramid of tax-efficient retirement planning.

Sorting through the different tax planning options may seem like a herculean task; however, the diagram below simplifies the decision process. The six levels of the pyramid graphic illustrate how clients are rewarded for advancing from traditional to more innovative strategies.

Level 1: The bottom level on the pyramid depicts how most of your clients receive their income. Their paychecks show heavy FICA, FUTA, SUTA, and other payroll

Climbing the Pyramid Enhances Tax Efficiency Taxes on Employee Withdrawals

Taxes on Contributions Minimal Tax on Contributions

6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account

Minimal Withdrawal Taxes

Moderate Tax on Contributions

5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan

Moderate Withdrawal Taxes

Moderate Tax on Contributions

4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund

Moderate Withdrawal Taxes

Moderate Tax on Contributions

3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp

Heavy Deferred Income Tax

Heavy Current Income Tax

2) Qualified Plans Profit Sharing Defined Benefit 401(K) 1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

taxes as well as withholdings for state and federal taxes. As indicated on many pay stubs, more than half of the income can be lost to taxes at level 1. Moreover, after-tax investments in retirement vehicles can trigger additional taxes, as indicated on the right side of the pyramid below and in the after-tax numbers on the above table. Obviously, clients need to find more tax-wise solutions!

The tax-deferred growth in retirement plans has helped Americans accumulate more than $12 trillion in employee-based defined benefit and defined contribution plans.

Level 2: Climbing the pyramid to level 2 affords your client opportunities to invest in ERISA qualified plans. Such plans include 401(k) plans as well 403(b)s, SIMPLE plans, profit-sharing plans and defined benefit plans. While employee deferrals used to fund qualified plans will still be subject to payroll taxes, the heavy state and federal income taxes are deferred until money comes out of the qualified plans. The tax-deferred growth in retirement plans has helped Americans accumulate more than $12 trillion in employee-based defined benefit and defined contribution plans. Without additional planning, this $12 trillion is all subject to ordinary income taxes during retirement or at death.

Level 3: Business owners and highly compensated employees often want more tax benefits than qualified plans afford. Too often, the top-heavy rules limit the amount of contributions by highly compensated executives. To work around the ERISA restrictions, financial planners offer a variety of non-qualified deferred compensation plans. These include traditional deferred compensation plans involving salary and bonus deferrals as well as more sophisticated plans covered by 409(A) rules on deferred compensation. Since 2004, however, the 409(A) regulations have increased the risk of current taxes applying to non-qualified deferred compensation plans, including restricted stock, phantom stock and performance share plans, as well as stock appreciation rights and long-term year bonus or commission programs. To minimize the risk of current taxes while accumulating maximum amounts, a variety of supplemental executive retirement plans (SERPs) have been used by executives to accumulate substantial balances. Now these executives face much higher than expected taxes on their withdrawals because of the higher marginal rates in 2013. This is spurring growing interest in Levels 4 through 6 of the pyramid.

Level 4: The Level 4 solutions include a variety of charitable planning instruments that allow for large income tax deductions when they are funded as well as tax-deferred growth on the plan balances. Moreover, the distributions may have only moderate withdrawal taxes. For example, charitable remainder trusts (CRTs) can distribute tax free or capital gains income. Gift annuities can pay out partially tax free income by returning the initial investment capital as part of each payment. These charitable tools can be customdesigned for each individual to start retirement income when income is most needed or tax rates are lowest. For these reasons, the charitable tools at level 4 can provide better bottom line benefits than those generated at levels 1–3.

Level 5: Clients focused on retirement security and income may reject level 4 solutions because “charity begins at home.” Fortunately, there are charitable solutions, such as a Super CLAT designed with the current low 7520 rate that can increase what goes to the donor throughout retirement. For substantial benefits from non-charitable tools, employers will often take deductions for a Section 162 plan or a Section 79 plan. For example, a company can make pre-tax contributions of $500,000 to a Section 79 plan so that an employee can receive tax-free income of nearly $1.1 million while also funding a tax-free

death benefit for his or her heirs that may be more than $1,000,0003. Visit our website for more information about this topic.

About the Author

Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www.

ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.

Level 6: Creative planners continue to find synergistic combinations of planning instruments that can provide benefits that exceed those illustrated in Level 5.

For example, the Family Retirement Account™ (“FRA”) leverages the benefits of universal life insurance using loans and a dynasty trust in order to convert taxable retirement income into tax-free cash flow and/or wealth transfers.

Capital Split Dollar (“CSD”) helps employers take income tax deductions for funding tax-free retirement and death benefits for key executives. While qualified attorneys opine that the FRA and CSD are within the letter and spirit of the tax code, the techniques may be too complicated for some clients. A simpler alternative may be the charitable LLC. $500,000 contributed can produce more than $2,000,000 for family and charity. The family benefits can exceed those of the Section 79 plan while also giving your client the satisfaction of redirecting tax money to their favorite charities.

Conclusion New tax laws, such as the 409(A) rules passed several years ago and the American Tax Relief Act signed this year, have curtailed many popular planning strategies. Wise planners, like Hercules, find that each time a head is cut off the hydra, two new heads grow. The decline in the demand for estate tax business is small compared to the big increase in the demand for income planning and retirement planning. Financial planners have immense opportunities to serve the tens of millions of clients who are stuck at level 1 or level 2 of the above pyramid. As indicated above, there are compelling reasons and great financial rewards for the clients who advance to levels 3, 4, 5 and 6 in the tax efficient lifetime income planning process.

1 http://vfos.com/webdocs/2013CaliforniaRates.pdf 2 The Federal capital gains rate is 20%. As noted in the above footnote, the California tax of 10.23% applies to married wage earners with only $97,884 of income in 2013.

3 http://vfos.com/webdocs/M45_SampleSection79.pdf

Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com

Climbing the Pyramid for More Tax-Efficient Lifetime Income Key Takeaways

New tax rules have created immense opportunities for savvy advisers

• Tens of millions of taxpayers who never had much concern about the high marginal estate tax rates are now very concerned about the new high marginal income tax rates.

by Tim Voorhees

• Most taxpayers who now have higher income taxes continue to pay unnecessary income taxes on their retirement plan contributions, accumulation, and/or withdrawals.

• Financial planners can help prospects and clients minimize income taxes by climbing up a “tax efficiency” pyramid that has progressively more powerful strategies the higher up you go.

• The most powerful income tax strategies are often funded with life insurance.

Impact of Investing Excess Income Tax Efficiently: With Tax-Efficient Planning Tools If 50% of Excess Income Lost to Taxes BeforeInvesting: If Investment Returns are Reduced by 38% Taxes:

Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein.

If 38% of Accumulated Value Lost to Withdrawal Taxes

Opportunities for financial planners increased dramatically in early January when the President signed the American Tax Relief Act of 2012 into law.

While the demand for estate planning shrank when the estate and gift tax exemption increased from $1 million per person to the new “permanent” exemption of $5.25 million per individual, the need for income tax planning grew substantially when the top marginal rates increased for most taxpayers.

Many clients will now have top tax rates of more than 35 percent on capital gains and more than 50 percent on ordinary income unless financial planners provide solutions.

The impact of the new higher tax rates is evident when projecting retirement savings growth over 20 years. For example, a business owner funding a retirement plan with $500,000 over the next few years can expect the plan to generate more than $1,760,000 of tax-free income—if money grows at 6.5 percent and there are no taxes on contributions or withdrawals. If, however, the executive is married with income of more than $450,000, marginal tax rates may be 39.6 percent at the federal level and 10.23 percent at the state level1. Our website has more information about this topic.

Together, these taxes reduce money going into Roth IRAs, retirement annuities, and related retirement investments by almost 50 percent. If the executive 20 Years at 30 Years at keeps the money in annuities or stock Now investments, there will likely be additional 6.5% 8% taxes when the funds are withdrawn. $500,000 $1,761,823 $5,031,328 Even if the taxes are at capital gains rates instead of at ordinary income rates on $250,000 $880,911 $2,515,664 withdrawals, the capital gains rate is now 34 percent for some people earning less $250,000 $580,265 $1,068,205 than $100,0002. This is because the Federal capital gains rate is 20 percent, and the N/A $359,764 $662,287 California tax of 10.23 percent applies to married wage earners with only $97,884 of income in 2013. If income is more than $250,000 for a married couple, there may be a 3.8 percent surtax as well, thereby raising the capital gains rate to about 38 percent. If the 50 percent