015 | How to Deduct Life Insurance Premiums with Ken Crabb

Patrick: Welcome back to the Vital Strategies Podcast. I’m your host, Patrick Lonergan, and today we’re speaking with an expert, Ken Crabb about a strategy that he developed over 20 years ago for a billionaire that allows life insurance premiums to be tax deductible. Make sure you listen to the end to hear how to set up the structure properly to be able to deduct life insurance premiums and how this tool fits into an entrepreneur’s financial life when it comes to level three tax planning.
We’re combining sections of the IRS code to create additional tax efficiencies. Oftentimes, the IRS doesn’t like this. Ken has a wealth of experience that spans decades. He’s dedicated to navigating the tax code so you can get the most out of your hard-earned dollars. Today we’re taking a deep dive into how business owners can deduct the premiums for life insurance policy.
In this episode, Ken breaks down the various ways in which these plans can be tailored to suit business owners looking for an efficient way to maximize tax savings while still being able to build wealth. So whether you’re a business owner who’s looking to add life insurance coverage to protect your family or business, or just learning more about tax efficient financial planning, this episode will help transform your financial future.
Let’s get started.
Ken. I am excited about our conversation today. We’re going be talking about their Restricted Property Trust. But before we get into that, it’s really an interesting strategy. Can you give us a little bit of background about yourself and how you designed this strategy?
Ken: Sure, yeah. My name’s Ken Crabb. I now live in Charlotte, North Carolina, but back in 19 ninety-nine, I was working for a billionaire family in Cleveland, Ohio.
They had come to me and I was running their life insurance silo for their family office, and they were insisting on corporate tax deductible life insurance. I was a young, eager beaver, twenty-five years ago, and I went out into the marketplace and I found forty-seven plans that purported to offer deductions for life insurance.
But I could not get any one of those plans passed either one of my client’s, two law firms. So finally, my client said, look, you guys got to figure this out. So, I sat in the basement with the attorney who litigated man construction, litigated McGowan. He’s handled all that stuff. But back when I was working with Sam ORISA, then he had had just passed the Bar Association.
He was a junior associate 25 years ago. He’s now a superstar tax attorney, and we came up with a Restricted property trust. We wrote our first trust in February of 2000. Think it was February 11th. Yeah. We just passed 24 years yesterday from our first trust. And I always say this, I don’t think we were smarter than anybody Patrick.
I really don’t, I don’t say that to be self-deprecating. When we were sitting down to design it, we were not thinking about marketing. We were thinking about defending. And when you approach a tax strategy from how can we defend this? If the IRS comes calling, it’s a very different outcome. So that’s why it was just so much more conservatively designed and that’s why 24 years later, here we are.
Patrick: Yeah, that’s fantastic. And I think the fact that you looked at all of those different opportunities to deduct the life insurance premium and none of these passed the sniff test, we better come up with our own strategy that is really going to work. I think that’s fantastic. And I think there’s also something in there that I don’t want gloss over.
The fact that this has been in place and you’ve been doing it for 20 plus years. That matters. because I’ll call it the Fly-by-Night Strategies don’t last that long. They get swatted down pretty quickly. So they do. And it’s always still funny to me, I think that digital media is like online fentanyl or digital fentanyl or something.
Because I still read negative stuff about the Restricted Property Trust and I’m sitting here going, wow, I have a hundred percent track record. It goes back 20 years. We’ve had dozens of audits. I’ve had litigations, I’ve been in federal court, I’ve been deposed by the Department of Justice. I’ve had my email subpoenaed.
And when I updated my last go-to meeting, I intentionally went back to my original slides from 2010. And this was in 2022. After I won Man Construction, I said, Hey. There’s going to be some different talk over, but I am intentionally using the same slides from 10 years ago because nothing’s changed.
Patrick: Yeah, I love that.
Ken: Nothing’s changed.
Patrick: That’s fantastic. I think we need to start unpacking what the Restricted Property Trust is and how that gives us the opportunity to really deduct the life insurance premiums that go into this employer sponsored plan. So can you start just giving us, we’ll start out macro level if that’s okay, and then start working our way down to some of the nitty gritty details.
Ken: Yeah, I love it. So the Restricted Property Trust, historically we’ve done it with small business owners. Average Trust probably has one and a half people in it. You can have more than one in any one trust. It’s just been recently that we’re now moving toward the public company market because of the federal litigation success.
So that will be huge, huge market for us. With the Restricted Property Trust, a business owner, if they’re saying, Hey, I really have a death benefit need, there has to be a business reason to purchase the death benefit. And that’s step number one. What’s the reasonable business purpose? Why are you doing this?
And you and I know in the insurance world, the insurance advisors are thinking about the commission and the clients are thinking about the deduction. They’re not thinking about the business purpose. So I’m always taking people back and going, great. You want to put $500,000 in here? I might be able to do that.
How old are you? What does your tax return look like? If your business isn’t worth $15, $20 million, I’m not going to be able to get that much money in here. So what happens? Then one quick side note. We wrote our first professional athlete in the summer of 2015, and pro athletes are really tough because they’re all young and healthy.
Otherwise they wouldn’t be professional athletes. They’re making tons of money and always wanting to put two common checks into these deals. And unless their name, image likeness is a household name, I have no business purpose. Yeah. So all the athletes that we now have are household names, so that’s step one.
But back to the macro level, we’re looking for business owners primarily making at least $650,000 a year. And the reason I like that number Patrick, is I want every dollar going into my plan to be coming from the top marginal bracket. So that’s the starting point to our earlier conversation.
When you get into a level three tax strategy that you need to be in the top marginal bracket before you start looking at it. And I get phone calls from people making $300,000 a year and their effective tax rates in the twenties, and I’m like, you’re not ready. You’re not here yet. Yeah. But once you get into that top marginal bracket, the business is gonna write a check.
And for every dollar that the business puts in the trust, it’s going to lower the tax of the owner by 70 cents. So if they were going to make a million dollars and they put a hundred thousand dollars in the trust, they’re going to now pay taxes on $930,000 and they have a whole life insurance policy.
Patrick: No, that’s fantastic. There’s a few different pieces that I want to unpack there. So first we couldn’t agree more on those marginal brackets. From my perspective, we like talking about level one, level two, level three strategies. Level one, we’re taking care of just that good administration, bookkeeping. Level two, we’ve got the 401k plan, maybe a cash balance plan.
And then once we’ve filled up level two, now we’re starting looking at level three. Because I think there’s another piece that’s worth considering here is like the complexity starts going up. Like I have a trust, I’ve got life insurance, I’ve got administration. I’ve got some rules that we’ll get into here in a minute that I need to be paying attention to.
And so this is not as simple as just putting money in in a brokerage account and waiting to retirement age to get it out now. Nope. There’s maybe better benefits than that. We start looking at it, but I think that’s a very important piece, and we don’t really like to see clients try to get down below the 24% bracket.
At max, anything lower than that, I’m like, the rates you’re earning, you know we’re going to be paying this tax. Why deduct twenty-four percent money to pay it later at thirty-seven percent? Like that Just doesn’t make any sense. Let’s just stop the deductions here and keep going.
Ken: So we’re at a hundred percent same page.
Patrick: Yeah, yeah, no, that’s fantastic. And really the great thing about this conversation is our listeners are entrepreneurs that are making a million dollars net income and up. So this strategy, I think is one that. It’s going to be great for them to really consider when we think about the life insurance need. So can we go back for just a second on the business need and can we just walk through some examples of a business need there?
I can think of like key executive, right? Like this person’s running the operations if something happens to them, that’s a problem. Yes. This business is going to see a dramatic decrease in value and we’re going to have to get somebody in here to run the operations to get it positioned to sell. But can you walk through maybe how we come about putting a business purpose in place there for the life insurance?
Yeah. There’s really only two. The first is buy-sell. I love that. because it’s typically rather concrete. You come in, you’ve got two entrepreneurs. They’re partners. They have a $10 million company, and we put $5 million of death benefit on each of them. That’s just middle of the fairway as it were. Then the key person, and I’m going to limit a key person’s death benefit in several ways for a business owner, I’m going to look at their W-2. I will go 10 times W-2 in death benefit without blinking because that’s the standard.
I will go five times a combination of W-2 and K-1 again without blinking. But then there are some places where it becomes a little bit more of an art than a science. One example is we had an electrical contractor who had a W-2 of $90,000 and had a negative K-1.
I put about a $16 million death benefit on him, and my operations manager emailed me thinking I made a mistake and he hadn’t seen the corporate return. But the corporate return was $97 million of gross revenues with $78 million of cost of goods sold. So I said to my ops manager, Tom, I said, Tom, if he dies, his wife has to need six and a half million dollars a month to keep the doors open.
I will have no problem defending $16 million here.
Patrick: Right? Yeah.
Ken: So that’s where we get that business purpose. So it varies a little bit, but the most cut and dry method is 10 times W-2 or five times W-two plus K-1.
Patrick: Fantastic. That’s great. And gives us some context to sort of wrap our heads around like how much coverage I can get.
And one thing that we also need to think about is it depends on how old that client is too, right? $60 million of coverage on somebody that’s forty-five is different than somebody that’s sixty-five or 70, right?
Ken: For sure. I’m doing a case right now for a couple in their mid-sixties, probably worth about $80 million and we’re doing $7 million each and the premiums a half a million bucks.
So they’re going to get a million dollar deduction and lower their income by $700,000. I had a successful twenty-six-year-old digital marketing girl in Southern California, living in her parents’ basement making 3 million a year, and she’s a triathlete and all this other stuff, and she wanted to put a half a million dollars in.
And I’m like, at your age and health, it’s $40 million of life insurance If you. A 60 five-year-old smoker, I’d have no problem.
Patrick: Yeah, no, that’s great. And I don’t want to run way down the rabbit trail of life insurance design, but we’ve seen policies designed different ways. So you can have a, I’ll say a lower death benefit and some higher cash values depending on the riders and that type of thing that you put in.
Or you could have a higher face amount on the death benefit with a higher premium going in. Do you want to just touch base on how you look at designing those policies to solve some of these problems?
Ken: Yeah, we don’t have a ton of flexibility in that regard. So one thing that I should have mentioned earlier, the Restricted Property Trust only uses whole life insurance.
And the tax reason for that is we’re only allowed to deduct the amount of premium required to fund the current coverage. You and I know in term insurance, it’s really, really cheap in any type of universal life insurance. It’s built on an annual renewable term chassis. So again, you might be putting $100,000 in and getting a $2,000 deduction in good old whole life.
Your contract premium is the amount of premium you have to put in, so I am stuck with whole life. The flexibility in the design comes this way. The maximum deduction I can do in any one year, and I won’t go down the rabbit hole here for the relationship between our two sub trusts, but as a 70% base premium and a 30% paid up addition rider, which is a cash stuffer, as you know.
For your entrepreneurs listening, it’s just a cash stuffer. When I am in a lower income tax state or a no income tax state, I will very often increase the, PUAs to 40% or even 50%. That lowers the current deduction, but the PUAs plus all the growth come out tax-free on the back end. So if they die in the five or 10 year period, I made a terrible mistake because they got less death benefit and less deduction.
But if they live, they will save more overall in taxes and have a higher paid up policy so that we really run them at 70% base, 30% PUA, 60/40, or even 50/50. And those are pretty much the only three designs we do, depending on age, length of funding, and state of residency.
Patrick: Fantastic. We could geek out on the life insurance.
Ken: We could definitely geek out on Yeah.
Patrick: Design for a while, but I think our listeners is probably like, just, can you move on? Give me the deduction with the death benefit. That’s what I need. Yes. Very good. All right, so moving back to design. We’ve touched base on a few of the different pieces. It’s an employer sponsored plan, there’s some trust involved.
So can you walk us through a few of those pieces and how they allow us to get this deduction?
Ken: Sure. So the first thing we do after we get an approval for the actual life insurance policy, we’re never going to go hire a law firm and pay them for something until we know we can do something with it. And I will say right now, this is just a public service announcement.
Any entrepreneur listening, they probably have a $8,000 binder of a trust work in their office and there’s nothing in it. Mm-Hmm. The great thing about life insurance salesmen is we’re going to make sure everything gets in there. because we don’t get paid until the planning gets done. Right. So the first thing is get an underwriting offer and then we set up a trust.
The trust is $5,000 flat. That’s because of the volume that I do normally. This is a very complicated trust. If you went to a law firm from scratch, it’d be $35 to $50,000. Yeah. But we can get them done a lot more efficiently than that. And the trust is a grantor trust under Subchapter J, the Internal Revenue Code, technically it’s a 402B trust, employee benefit trust.
That’s nice. It’s protected from civil litigation. All 402B trust are for folks that get worried about that, but you’re funding the policy, you’re funding the trust, and then the trust is actually funding the policy. The only thing the trust owns are whole life insurance policies. And the trust is also the owner and beneficiary of the policy.
So if the insurer dies, the trustee gets a check from the insurance carrier, picks up the beneficiary designation agreement, and then pays it out. So that’s the intermediary that we’re creating every time. And I should mention, it’s additional a thousand dollars per person. So a three person trust would be $8,000.
Really, I’m very proud of the fees. I’ve worked really hard to get them that low, especially on the trustee side. The only fees the Restricted Property Trust has a year two and beyond is $750 per policy, which is, you know, what’s a cross-tested cash balance pension plan. Four grand, five grand every year.
And it’s really very reasonable. All tax deductibles. We are going to attach that trust to one corporate entity. I know some of your entrepreneur clients have 15. So when I’m looking for a reasonable death benefit, I’m going to ignore 14 of those companies because I have to justify the amount of the death benefit based on the loan tax return on which I’m providing.
So that’s an important point. I have one client. It had 500 TGI Fridays, and for our listeners, please get over that. I thought there were eight TGI Fridays in the United States. Apparently there’s at least 500. But every single Friday’s was in a separate partnership and he had a management company and I could really only ensure his key employee value to the management company rather than his $200 million empire, if that makes sense.
Patrick: Got it. No, that’s great. So just a quick trust question for a second. So does that trust move the life insurance out of the entrepreneur’s taxable estate? Do we get some benefit there?
Ken: No, and several reasons. One, estate planning is a personal purpose. So that would not justify a business deduction and what we’ve done for estate planning, it stays in there.
I’ve had clients. I don’t know how technical you want to be today, but claim the table 2001 rate is a completed gift for an islet, and then when they vest, they roll the policy directly to the islet. I still don’t recommend that because whole life with our PUA has a lot of cash value per death benefit.
So even in my own personal planning Patrick, I have a very large survivorship IUL with my wife. And a large restricted property trust. I’m planning on funding both of them for 15 years, rolling out of my restricted property trust and then using the cash value and flipping my SIUL from level two increasing.
Maybe we’re starting to geek. You’re getting too excited. You’re already smiling too much.. I’m starting to use it all fancy. As soon as I get technical you get all excited about it.
Patrick: I do. Yes. This is fantastic. because I, I think there’s so many strategies out there that you can start combining together to create some efficiencies that are absolutely worthwhile. So, sorry, I didn’t mean to interrupt, but please continue on.
Ken: Oh, it’s huge. And so my plan personally is I don’t want to have $4 million in my whole life policy with a $9 million death benefit. I’d prefer to switch my survivorship IUL from level two increasing and then crank that money and make that death benefit go up for our three girls.
Or if my wife and I need money, the heck with my girls, I can take out an income stream of $285,000 a year tax free for 20 years. Yeah, I love it. So either way, I think the biggest thing that we are supposed to do as planners, and the reason I like working with people that see me as one piece of a puzzle and not a shiny new toy, is because I want to make sure that five years from now, 10 years from now, people still have decisions to make and options, right?
So just build in some flexibility.
Patrick: Yep. That’s fantastic. Thank you. One of the things I want to dig into a little bit more is the trust structure. So we’ve talked a little bit about the trust, but there’s some restrictions. It’s a Restricted Property Trust. So can we talk a little bit through those restrictions?
Because we just like to be very clear, anytime there’s an opportunity for tax deduction, there’s usually some strings attached to that. If there’s not, generally we advise our clients, you should probably run away because it’s too good to be true and you don’t want the Department of Justice coming to knock on your door going, Hey, come with us.
You’re going to jail for tax fraud. So can you tell us a little bit about the restrictions on the trust?
Ken: Yeah, for sure. To your point as well. pre-COVID. I used to go to a lot of hotel ballrooms and speak at CPA CE tax conferences. I was one of six presenters, and I ended up participating in a lot of the other presenter strategies personally.
But anytime I heard a guy start off with, Hey, here’s a current deduction for an appreciating asset, you get back tax free. I’m like, I’m going to go to the lobby and check my email. Yeah. Because I know you can’t do that. You can defer taxes, you can time taxes. You can leverage taxes. You just can’t avoid taxes.
So, so the term restricted property comes from section 83 in the Internal Revenue Code, which is titled Property Transferred in Connection with Goods and Services. The most common form of property that gets restricted in the United States is stock, stock options. Most stock options are 83B property, and I bet you that’s over 90% of the restricted property in America.
But you can do it with anything. Patrick. If you said to me, Ken, you seem like a great employee, I’d really like to lock you up. I have a garage behind my office that’s worth $30,000. If you work for me for five years, I will hand you the title to that garage that is now a plan of restricted property under section 83, which means I could go and say, Hey, Patrick, I love working for you, that garage is the bee’s knees. I’m going to pay tax on that 30,000 even though I’m not guaranteed to get it in the future. Mm-Hmm. If I go take another job in two years, or you fire me in four years, I am not going to get. That garage, and I’m not going to get my tax money back. However, the reason people do it, and if you were at Google back in the day, I hope you made a bunch of 83 B elections.
But if you elect to include that and a shopping mall goes up across the street, so my little garage is now worth $200,000. When you hand me the title, it functions like a ROTH IRA, that is a non-taxable transfer to me. The problem we had, and I’m getting to the bad news, is our first client was a billionaire.
We did not believe, we could argue that he would fire himself. We did not think that would hold water. And the most novel part of the Restricted Property Trust is we invented a risk of forfeiture. And we said, all right, how about the company has to pay it for no less than five years, and if they can’t pay it for any reason, the trustee, third party, independent institutional trustee, it’s not, I’m not the trustee.
There’s no connection to there. It’s really important that the legal advice, that third party administration and the trustee are all three separate legs of the stool. They will surrender that policy for cash and they will give it to the charity that the client previously selected. And we would not let our client use his private foundation.
And I don’t have a good tax reason for it. I just didn’t like the optics. Yeah. So I just like, ah, I’m not really sure that’s going to be a forfeiture. So he picked the Cleveland clinic, which is great, and I’ll tell you the best. So that is our substantial risk of forfeitures you are committing in five year rolling windows.
I will tell you the fastest audit I ever had was in early April of 2020. It was a dentist in Columbus, Ohio, and this little field agent, I’m sure she was in her mid-twenties and had one class on an 120S in her life. And she’s asking me questions and she finally, I explained it to her and Hey, I. This part’s deductible today, but if there’s any value to that in the future, they’re going to pay tax on that portion.
So we’re really just deferring. And she said, well, that doesn’t make any sense because he’s the dentist and he could just choose to pay the premium. And I said, wow, that’s right. Hey, could you call the governor for the state of Ohio and let my client open up his dentist office? Because apparently you’re under the impression that business owners operate in a vacuum and outside forces don’t exist.
So if you get the governor to let him go clean teeth, I will agree with you right here and now. And one of the silver linings of Covid is a very inexperienced IRS field agent went, Oh. Oh yeah. Okay. I don’t have any more questions on this part of the audit, and so I was involved in that audit for 35 minutes.
Yeah, I love it. So that is your risk of forfeiture you are committing. And to our conversation before we got on, I actually have a business purpose to put more money into my trust than I do. I do $350,000 a year, but I have two girls in college and I’ve got one more daughter at home. And the question I asked myself is the same question clients should be asking themselves is, what could I fund if I wasn’t working for the next four years?
I could do nine. I have a business purpose to do $950,000 in my trust. Could I fund $950 the next four years while I’m doing everything I’m doing? It made me nervous. Yep. And I can fund three-fifty and not lose sleep at night whether I work or not the next four years. Yeah. $950, I don’t know.
Patrick: Yeah, no, that’s fantastic because one thing that we look at with our clients regularly is we’re managing cash flow.
It’s very important to being able to fund tax strategy and fund the business and do the kitchen remodel and add the garage, and all the stuff that our clients like to do. We have to make sure that we’re not running too low on cash, and we also feel like on the upper ends, inefficient. So yes, I’m just thinking about this strategy going, I would probably feel comfortable going, all right, I want the dollars comfortably set aside in a brokerage account.
Now, emergencies can come up and I might need to grab some of those dollars for operations or. My kid decides to go to Harvard versus the state school or something along those lines, like those things can come up.
But I think that liquidity piece is super important to funding this strategy because I love a tax deduction, but I am also planning on these dollars being an asset for me down the road. And if I’m only able to fund four out of five years, that’s a problem. Right.
Ken: It’s a very bad result. I tell clients the only thing that can go wrong is you miss a payment.
It’s whole life insurance. Our enforced ledgers are running over ninety-nine percent accurate. I mean, it’s a beautifully boring product, so I don’t have to deal with any of the market correlative stuff. It just functions. But the one hiccup that the Restricted Property Trust can have is it doesn’t get funded.
And that was a big issue in court for me because they thought the risk of forfeiture was illusory in the first year of discovery. Because I had had four deaths and 19 forfeitures. And eight of the forfeitures came from one trust. So maybe it’s 12 forfeitures, you know, whatever. 11 forfeitures plus those eight.
But yeah, I mean, we had a restaurant owner, we had environmental company, we forfeited trusts. We had three trusts, forfeit during covid. And it literally breaks my heart and tears me up and I do everything. I did have one restaurant owner in Palm Springs. She had her fifth premium coming up and I said, call your banker.
Pass the hat with your friends and family. Just put $75 grand in 13 months from now. Tell your friends you’re going to pay all of them back. And she was able to pull it off. So I was so excited that she paid her fifth premium. Yeah, but the way I say it too, Patrick, which is why I love working with a firm like yours and me just being a piece of the puzzle, is if you’re going out for a big steak dinner.
The Restricted Property Trust is your brussels sprouts. I don’t need to be the 14 ounce bone-in-filet. You know, do all that other stuff. But when you’re ready for an advanced plan like this, I don’t want any of the clients skipping a trip to Europe because they have a hundred thousand dollars premium come and due for the Restricted Property Trust.
Patrick: Yeah, this is great. So there’s a few questions that pop into my mind that I’m curious about, and I’m guessing I know the answer to this, but I want to ask it. So you were talking about that client that’s like trying to get the dollars together to fund this last premium. Can they borrow against, can they collateralize the life policy?
Ken: No, because they don’t own the cash value. One quick thing to maybe jump into the trust, there’s actually two sub trusts in our trust and they have separate EIN numbers. One of the trusts, the death benefit Trust always houses all the death benefit. The other trust is the Restricted Property Trust always houses all the cash value.
That’s super important because if the insurer dies, the death benefit’s never subject to forfeiture. Mm-hmm. There’s three potential beneficiaries. The death benefit trust might go to the beneficiary of the insurance policy. The death benefit trust may go to the insurer when they vest. Or the Refractive Property Trust has a different beneficiary and that’s going to be a 501C3.
Sure. Quick side note though, Patrick, my personal charity is our donor advice. So I am comfortable with donor advice funds. It is technically a public charity. So, although I won’t do a private foundation, I still have never done one. I just don’t like them. I will use a donor advice fund. The one caveat is for public companies, they don’t have to surrender to a charit if an executive leaves,
They can actually get the cash value back as taxable to them. But that is because the ownership of public companies does not reside inside the entity in private companies. It resides inside the entity. Yeah. And so that would be corporate reversion, which would disallow the deduction.
Patrick: Yeah. This is great. The reason I’m sort of digging into these is we think about our level three tax strategies. Where we’re taking sections of the code and we’re combining them together to get some real efficiency. I’d just like to articulate like there are strings attached to this. Like I really haven’t taken, I don’t know if the right term is receipt of this property.
Like I don’t technically own it. I can’t collateralize it. It’s sitting in here in the trust and it has some rules around it, and I’ve got to make sure I meet all those rules just like I do in my IRA. I can’t take those dollars out until 59 and a half without tax and penalty and all these other things.
So it’s like. We very much have some structure around these dollars that are allowing us to get the deduction and have some real benefit to a charity if I don’t execute on this thing. So I think that’s fantastic and really like to take a point.
Ken: One quick housekeeping note, I only do annual premiums because early on in my career I was working with a lot of plastic surgeons.
Mm-Hmm. And they were funding quarterly. I never let anybody do monthly. But I realized that they were funding quarterly because they didn’t have the annual money. And I’m going, well where’s next year coming from? So I just decided if you want to put a hundred grand in and you can’t stroke a check, that’s too much money.
I’m not doing quarterly, semi-annual, monthly, all premiums are annual for just that reason. And then I only have to go through the torment once a year with every trust of whether or not they got funded.
Patrick: Yeah, absolutely. And one thing that, you talked about it briefly, but I think it’s a very important issue, is you talked about the cost.
So, the cost is really low for executing on this strategy. Yeah, we see some strategies that cost 40, 50, 60, a hundred grand to implement, and when we think about the cost, we look at that just like a tax. So I can either send it to the IRS or I can send it to a professional. If the fee’s less than the tax, like a lot of times that makes a lot of sense.
But yeah, when we’re looking at a structure like this where I get to deduct 70% of the dollars and the setup cost is really only five grand plus some additional costs on top of that for each individual, like that’s not out of line at all. It sounds very, very efficient from my perspective.
Ken: So, well, I can tell you the first trust that we wrote with the research and everything that went into it was $138,000 in 1999. So that’s pre inflation money. So that first trust today would easily have been over $250,000. And now we’re doing it for six grand.
Patrick: Yeah, that’s fantastic. This is great. So I think one thing we also like to look at is there’s a little bit of, can we just bring Dave Ramsey into the mix where he says, don’t buy whole life, you know?
Buy term and invest the rest. So we always like to look at compared to what. If we’re comparing this whole life policy with the tax deduction to a, we’ll call it an after-tax investment. Now, I know there’s lots of factors that come into this when we’re talking about design. You know, we were talking about paid up additions and age of the insured and all those other factors.
But if we just look at a typical example, and maybe you can outline what that even means, what kind of after-tax return are we looking at from a, just a comparison perspective.
Ken: So when I get on the phone with a prospective Restricted Property Trust client, the only piece I pull up is a cash flow comparison, and I’ll use a 50% top marginal rate.
We’ll pretend we’re in California or New York right now because it’ll just be easier for our heads. Sure. But I’m saying, look, if you want to put a hundred thousand dollars into your savings account, you have to make $200,000. That is the math. If you want to put a hundred thousand dollars into a restricted property trust, you’re paying phantom income on $30,000, which is $15.
So you need to double bonus that portion. So I need $130,000 of gross income to get a hundred into my plan. The question then becomes is what do you have to do with $65,000 to keep up? Because that’s all you get to keep after that, and it usually comes out to about 7% or 8% fixed. And really when you look at the taxes going in and the taxes coming out, all the restricted property trust is, is you’re buying a whole life insurance policy with about 80 cent dollars instead of a hundred cent dollars.
That’s it. That’s the magic. But when you do that, you go from about a hundred basis point rate of return over 10 years to about an 800 basis point rate of return over 10 years and 700 basis points is a pretty good number.
Patrick: Absolutely it is. And I think we can’t discount the fact that, like you said, your illustrations are ninety-nine percent of what you issued those policies at.
Like they just do what they’re designed to do. There’s no fluctuation. They show up and they produce, and to get those guarantees baked in, like that’s really worth something. So.
Ken: Yeah. It is funny. Whenever I get bad press online, no restricted property trust. Especially the ones that have been audited and gone through litigation, they’re just confused.
They’re like, what are you even talking about? This has done absolutely every single thing that it was supposed to be. Yeah. So they find it amusing when they find nasty articles about me online. I don’t find it in using by the way.
Patrick: I can imagine. It’s like why the hate? You know, I’m just out here saving people on income tax.
I don’t understand. Well, the hate comes from when you have other insurance carriers that I don’t work with and I take cases from them. Shockingly, they tend to write nasty articles about the Restricted Property Trust. That’s just good old fashioned American competition, so that’s fine.
Patrick: Yeah. The truth will prevail. Hopefully this helps get the word out and uh, it’ll be good for our clients and you. In my mind, like every dollar we don’t send to the IRS, putting it back into the hands of creators, the entrepreneurs that sort of drive this economy, I think is a great thing. It seems like from my perspective, a dollar goes into the bureaucracy and 5 cents trickles out to the wrong people.
And I’m like, I would be okay paying a little more tax if I felt like it was used well, but that’s not the case.
Ken: So my number one favorite story of my career is I sold a million-dollar policy to Guy-owned car dealerships in India. He hated life insurance with a passion. The only thing he hated more than life insurance was taxes.
So he did it purely from an investment. Didn’t want the life insurance. This is not where the story gets good, but it’ll get good at the end. He was diagnosed very quickly with pancreatic cancer preferred plus non-smoker in his early fifties. Pancreatic cancer died before his first policy anniversary.
Our trustee cut his son a check for $16 million who wrote a check to his two sisters for $8 million a piece. Yep. The mom called my partner advisor on December 26th, 2017 and said thank you so much for using a tax deduction to trick my husband into buying that life insurance policy. because everybody was over here.
My kids and grandkids were over here yesterday and nobody was fighting about money. That’s all Mom cared about. And that’s what the Restricted Property Trust did.
Patrick: I love that. Yeah, that’s fantastic because that buy-sell piece, especially in a family dynamic, we see this regularly. You’ve got one family member that is like in the business grinding away.
You’ve got these other family members not in the business, and they feel entitled to some of that equity. And it’s like, not that they’re necessarily wrong, but it’s really nice when you have life insurance proceeds to just solve that problem versus taking on dead and. Or bringing on business partners.
Ken: Well, yeah, sibling doesn’t want to be their partners.
I’m so glad you mentioned that. because that is literally one of the number one uses of restricted property trust. Our family business is where one or two kids are not in the business. Yep. And they literally, dad or mom puts a big life insurance policy on themselves, gives it to his kids in the business to buy them out.
So then everybody’s happy, terrible story. Good at the end, but I had a guy making about 4 million a year. He sold pumps that keep Navy boats afloat, and he had one work that got hit, so he’s on Backorder for like five to seven years, making 4 million a year. And his son’s in the business, his two girls are not.
And I’m sitting in the conference room with he and a CPA and the advisor and I said, well, what’s your plan for your daughters? And he said, oh, I, I bought $4 million of apartment buildings. Smart guy. Mm-Hmm. I said, well, what’s the cash flow on that? About $120,000. So your girls are going to get $60,000 each and your son’s going to get $4 million a year for the next seven years, and you’re under the impression they’ll be speaking by Christmas.
Right. I said, they won’t even be friends. And the CPA jumps on my side. He’s like, I. This is what I’ve been trying to tell him, and he’s like, well, how do I do that? I said, look, it’s not 4 million guaranteed for the next 20 years. It’s not annuity. He’s got to run a business. But sit down with your family and say, what’s fair if I get a $12 million policy and give you guys 6 million each tax?
Will you stay friends with your brother? I mean, literally, that’s the way to have that conversation. And he went and did it. The girls, God bless him, settled on 7 million each and we sold a $14 million policy and now he and his wife are sleeping way better. Yeah. Because I’m telling you, if he would’ve died without doing that, the wife would’ve been around with kids that don’t speak to each other.
Patrick: Yeah. No, that’s fantastic. And I think you’re highlighting a few things that we think are critical. We really look at five areas of planning. It’s tax, legal, investments, insurance and cash flow. And we do see life insurance as a tool, but we’re not trying to solve every problem with life insurance. You know?
It’s like there’s times when it makes a ton of sense. We’ve talked a little bit about how, I’ll say it’s a fantastic bond alternative, right? The fact that I can get a guaranteed 7% equivalent rate of return. Yeah, like that’s awesome. Then we think about the leverage of that return. If something happens to me, if I pass away, I get the life insurance proceeds.
That’s wonderful. And then we start factoring in like, okay, we’ve got these other problems. How do I solve getting dollars to kids not in the business? How do I solve an operations problem if I pass away? Like we need some liquidity in those scenarios, and we’ve just not found a better tool than life insurance.
Now, it might be term insurance, but if you’re getting older, that’s not a great opportunity to solve the problem because you might outlive the policy. So.
Ken: Well in term insurance, I always tell everybody this whole life insurance is actually the cheapest form of life insurance. If you live Thirty-one years every time, because you know universal life, you’re going to get to an annual renewable term rate, that’s pretty big. And term insurance after 30 years. And the reason, I forget the percentage, I haven’t looked in forever, but it used to be over 98% of term life insurance policies never pay out. And that’s why it’s so cheap. Yeah, absolutely. Because people don’t die in that ten-year, fifteen-year period of time.
So carriers can sell it cheap. You know, one mistake I think we make in our business, Patrick, is people try and put, and I have to do it because of business purpose. So people, is this for estate planning? Is this for key man? Is this for buy, sell? Is this, I will tell you, if a patriarch or matriarch that was generating revenue dies and someone shows up with a big fat tax free check.
You’re helping something, right? You’re helping period. Absolutely. My dad passed away in 2021. Big, big believer in life insurance. He had a ton of money in his defined benefit pension plan that I always yelled at him about because it’s a 100% estate taxable and a hundred percent income taxable, and I’m like, I.
My brother and I are going to split 13 cents on the dollar. So when he turned sixty-five, I made him buy a $5 million whole life policy with required minimum distributions from his defined benefit pension plan.. And I said, that’s the pension replacement So he did.
My mom got that and she’s fine. Anyway, but. My brother and I feel like we replaced his pension with whole life insurance.
Patrick: I love it. That’s wonderful. Ken, this conversation’s been great. So, if you could outline maybe a few different examples of like who’s an ideal client. We’ve already talked about need an income of $650,000 and a business owner, but can you walk through maybe a few other characteristics that you’ve seen this just be a, a fantastic fit for.
Ken: Yeah, you bet. With some of our larger restricted property trusts, say it’s a large group of doctors. I think that’s maybe the best way to describe the ideal candidate. I’m going to have the younger guys and gals that are still paying off student loans and just got the big fancy house and mortgages and they don’t have the cash flow.
They’re not there. I’m going to have an older group of docs that are going to retire in the next five to seven years. So, I go into that middle patch. I’m fifty-three now. I think when I was forty-eight, that was when my first year, half my clients were my age or younger. Now that I’ll be fifty-four, you know, now it’s like 60%, but it really seems to be that sweet spot of, call it 35 to 60 for an age.
I will write the oldest restricted property trust we ever wrote was on a sixty-eight-year-old. But that’s a family business and he’s going to die with his boots on, you know, he could still fund it for 10 years, even at sixty-eight. because he’s going to be around forever. I mean, until he is not, and that’s why he has the death benefit.
So we talked about the five-year risk of forfeiture. So liquidity, you and I touched on, I would love to know that you guys also run their investments and they have four years of liquid assets available. Human mutual funds can be, but it’s easily accessible. Non-qualified money that they can get to in a hurry times four.
And then that would be the max premium that I personally would be comfortable with. I’ve had clients go differently there. So you take the plastic surgeon in South Beach making $4 million a year that has $11 in his checking account. He is not an ideal candidate for the Restrictor of property, just he should be.
Mm-Hmm. And I had clients like that that called me every December to say they were scrambling to come up with a $250,000 check. And I’m like, you make $4 million this year, stop buying Ferraris. Yeah. But I’d much prefer the dentists. And Wichita will make an $800,000 a year with $2 million in his checking account.
That’s an ideal client right there. I think a great scenario are larger medical groups, because we haven’t touched on this yet. Patrick, unlike a qualified plan, this is fully selective. And not just vertically between business owner and receptionist. Also horizontally between partners. So you can go into a large doctor group.
That’s why we’ve had so much success there, or larger law partnerships, or even CPA partnerships. Just say, what do you want to do? And very often we’ll go into a big orthopedic group and just write two orthopedic surgeons that year. because their partner’s like, ah. And meanwhile they’ve been trying to do a qualified plan, a sophisticated one for five years, and nobody can agree on anything.
Well, guess what? With the Restricted Property Trust, you don’t have to agree on anything. So that really has been that for the inflexibility of the five-year commitment. The flexibility of setup and design, I think overcomes that. I’d say this. Have a client picture their asset allocation pie chart.
What slice of pie would you dedicate to an investment earning a seven or 8% fixed rate of return with a free death benefit? It’s a number, right? That deserves a place on your pie chart, right?
Patrick: Mm-Hmm. Absolutely. And one thing that we didn’t touch on is, we’ll call it the five-year increments. Oh yes. Can we talk through that?
Because there’s a five-year period where, right. If I can’t fund it, but how about 10 years, in 15 years? Why would I select a longer period of time? Could we walk through a little bit of that design?
Ken: Yes. Typically you’d only select a longer period of time if it’s going to be less than 10 years. We do a lot of seven-year trusts because of the MAC issues.
I can make a trust look pretty good, you know, five years, this is still whole life. Our five-year trust. The investment results about a wash and you had free desk time is like owning a term policy if you only go five years. The way the law reads is it says any plan must be no less than five years and any plan extension must be no less than five years.
So if you’re thinking 10 or 15, you would never sign a trust for more than five. Then what happens in practice is we’re going to go ahead and send you an invoice in years, its two, three, and four, about forty-five days before it’s due. It’s always at least 30, but my team is way ahead. And then on your any five year premium, if it’s a five or a 10, and fifteen’s, as long as you can go.
But if it’s a five or a 10, we’re going to send that closer to two and a half months before just to give us another month to say, Hey, let’s run some enforced ledgers. How’s your business? Because you have to execute the amendment to extend it prior to paying your fifth premium, otherwise the forfeiture would’ve lapsed.
So you have to extend it before the forfeiture lapses to go that other five. But you have some time and. I would say ninety-five percent of our trusts are five-year trusts. Planning on going 10.
Patrick: Mmm-Hmm. Great. So let’s say I get to that 10 years, I funded it that whole time. I’ve gotten my deductions all along the way.
What happens when I want to get the policy, let’s say, out of the trust? Can we just talk through what that means?
Ken: So it’s a very actually simple process. The trustee sends what’s called an indemnification and release letter, and all they’re saying is, because technically the insurance company pays the trust and then the trust pays the beneficiary.
So the trustee is saying, Hey, I’m not going to have these, you have to sign something that says I don’t have this death benefit. So as soon as the client signs that, we’ll go ahead and submit the ownership transfer form. They can transfer the policy in kind so it’s coming out with all the death benefit and all of its cash value in kind sometimes to the insured, sometimes to another trust.
I don’t really care who the new owner is, but they will vest in that policy, and this is actually a really good thing to bring up. They paid that 10 premium. They’ll vest in the policy usually about a week or two after that 10th policy anniversary. So you’re going to have about two weeks for some policy management.
You can’t do anything to manage the policy before the ownership changes. It’s like, okay, do you want to do a reduced pay down? Do you want to, I mean, you’ve got a couple of weeks to make that decision, so that’s always a bit of a hassle. I wish the insurance companies would get that done in one business day.
Patrick: We’ve been working on a client right now, they’ve got a collateralized policy and the bank is saying, yes, take some money out. It’s been such a slow process. They’re like, the money’s coming tomorrow. We’ve heard that for about three weeks now. And we’re like, okay, this is ridiculous.
Ken: So if I can interrupt you, Patrick, you brought a premium finance RPT cannot be collateralized as we’ve discussed earlier, but all of our largest cases are usually in conjunction with a much larger premium finance estate policy.
We’ll fund them both for 10 years. They’ve got nothing to do with each other. They’re just concurrent strategies. And then when we roll out the restricted property trust, we do the reduced paid up, and we use that cash value to pay down the note on their more efficient leverage policy. So the premium finance strategy risk is reduced of the leverage because we’ve got this whole life asset that’s not collateralized at all, and they generate some income tax deduction along the way.
It’s a beautiful combination.
Patrick: I love it. And you’re absolutely hitting on points. We like to take all of these strategies, figure out where the client’s going. because at the end of the day, there’s an unlimited number of planning opportunities and it’s like, okay, what’s important to you? Let’s start taking some of these pieces from RPT to Premium finance to even qualified retirement plans, like some of these things can all work really well together and we can come up with a strategy that like starts checking all the boxes and it’s a lot of fun. It’s a lot of fun designing these things.
Ken: It is fun. I always was drawn to the Restricted Property Trust initially because it was on a corporate tax return, on a personal tax return. It was life insurance, it was investment with the cash value. It just kind of touched on every part of a person’s life. I could geek out on that stuff like you do.
Patrick: I love it. Yeah. Very good. And we just like to look at these opportunities and see all the benefits and also the potential risks that are out there.
Is there anything from a downside that we haven’t talked about that we should be aware of with RPT?
Ken: Now the wonderful thing about the 100% track record is, and I should say this too, and I think the reason my clients get confused if they see anything nasty, every single audit and litigation all the way up through the sixth circuit court of appeals, if you Google the man construction case.
That was a $43,000 tax case that I spent about a million dollars defending. No client, their right mind would do that. Right. So I’ve defended every single plan 100% at my expense for 24 years.
Patrick: That’s fantastic.
Ken: And when I say that, I think a lot of clients are like, oh no, we’re going to get audited. That is absolutely not true.
Our audit hit rate, the national average from 2000 through 2020 was 0.7. 3% of tax returns got audited. My audit hit rate at the time was. Less than 0.5. No I’m not triggering audits, but guess what? When you have a couple thousand trusts in force, if I have 10 audits this year, that would be very normal.
Patrick: Absolutely.
Ken: You know, rest is part of life, but I take the tax risk to zero essentially with that. I can’t take the audit risk to zero. Nobody can do that, but I can take the tax risk to zero. The audit risk is what it is. The five-year risk is absolutely not a wink and a nod. That is the biggest downside of the Restricted Property Trust. Unless you are a public company.
Patrick: I love it. Yeah, this is fantastic. Can I appreciate all of the wisdom and insight. You know, when we think about wealth building, every dollar we don’t send to the IRS that we can put into something that grows tax advantage is fantastic. And really there are very few, if any other opportunities to fund life insurance where we get a tax deduction. And so.
Ken: I think this is, I think it’s there. I think this is it. Yeah. I always tell people it hasn’t changed, but I feel like Boris Gump in the shrimp boat. I’m the same old shrimp boat, but all the other shrimp goats got blown away in the IRS hurricane.
Patrick: Yeah. I love it.
Ken: And by the way, Patrick, what’s your risk of forfeiture on your tax money? A hundred percent. It’s a hundred percent every time.
Patrick: Absolutely. Yeah. None of that is coming back to me, ever.
Ken: Right. Ever. That’s good. I’m being spent so wisely all the time. It’s just great.
Patrick: Yeah. That’s wonderful. Anything else to add that we should maybe throw in that we didn’t talk about?
Ken: I was thrilled you stuck in the collateralized policy. because we have done this, you know, if I did five of these last year, they were all my million dollar premium cases. Pharmacy’s guy needs $250 million a death benefit.
He goes and finances $225 million and did a $25 million RPT. We showed it that way, working together. I actually spoke for Succession Capital a number of years ago out in Vegas, and Dean DiMarco, who was at Succession at the time, we ran all these spreadsheets. You’ll geek out on this. The highest IRR at life expectancy was never anyone’s strategy.
Never couldn’t do it. The highest was actually depending on age and some other factors. About 80% premium finance, 80% to 85%, and 15 to 20% RPT. Wow, that’s awesome. That was the overall highest IRR at life expectancy of everything we looked at.
Patrick: Yeah, that’s great. Ken, I appreciate this. This has been a fantastic dive into the Restricted Property Trust and I, it’s such an asset, you know, for the business owner, we get tax deductible, life insurance premium that solves a business need.
Then we can get the dollars out and use them tax-free. That’s pretty fantastic. So we do appreciate this conversation and we look forward to working together in the future.
Ken: You had fun. Thank you so much, Patrick. All right, wonderful. Have a great night.
Patrick: Yep. Thanks a lot.
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