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The Personal "Front" - Home and Retirement
An article by Lee R. Phillips, Esq., taken from the July/August issue of HBMA Billing.
Business is where you make your money
and home is where you have your family and want to retire. This final
installment of my series will concentrate on ensuring that you protect
your personal residence and provide for your retirement. This will not
be your standard retirement advisor's pep talk.
How to Protect Your Home
The personal residence may be the hardest asset to protect from
your business failures, lawsuits, creditors, and other wolves. Most
states have some sort of "homestead act," but the law only protects a
minor value in your home ($15,000 - $60,000). If you live in Florida or
Texas, you are home free, because those two states have a basically 100%
homestead act: your house is protected. For the rest of us, losing the
house can be an issue.
To protect your house from many of your "personal acts," a
homeowner's insurance policy with a good umbrella provision is the first
step. It is inexpensive insurance for the asset protection that you
need to protect yourself from the kid jumping on the trampoline in your
backyard, the neighbor falling on the sidewalk, your kid doing something
by accident to your neighbor's house, and lots of other problems.
Verify that your insurance has broad coverage, then beef it up while
making sure that your policy provides replacement-value coverage for
fire, theft, and other eventualities.
I hear lots of "plans" where the house is held in an LLC,
corporation, land trust, or some version of the three. Those plans won't
work.
Note that a land trust is different than a living revocable
trust. In theory, it is a revocable trust, but the folks who are pushing
them don't tell you the whole story.
You need to know that revocable trusts do not provide any asset
protection. No matter how fancy the land trust advocates are, there is
not going to be any asset protection using these trusts. Additionally,
you will be giving up the tax benefits of your personal residence and
any homestead protection that you might have.
Your personal residence is one of your most important tax
shelters. You can deduct the mortgage interest payments, then you can
sell the house and claim any profit tax-free – within the limits.
When you put your residence into a company (corporation, LLC,
limited partnership, most land trust structures, etc.), you are giving
up ownership, and the place you live is no longer your "personal
residence." It is simply a building, owned by a company, that you happen
to live in. You have lost all of the advantages offered by a "personal
residence."
Have the Spouse Own the House
In non-community property states (the 42 common law states), if
you are married and your spouse doesn't have a high-liability
profession, it may be a good idea to own the house under your spouse's
name. If the house is in his or her name, then if you are sued, as a
business owner or for any other reason, the house is not an asset that
you own. Consequently, it cannot be drawn into your fight unless your
opponent can draw your spouse into the fight as well.
Note that you and your spouse may be filing a joint tax return.
Therefore, you will not lose the personal residence tax shelter by
having your spouse own the house.
Love has nothing to do with ownership of assets. Be smart and
divide the ownership of assets in your marriage. Done properly, all of
your assets aren't in one basket anymore. Have the assets owned by your
living revocable trust or your spouse's living revocable trust instead
of having the assets owned directly. That way, if your spouse (or
partner) dies, you will not have to probate the house that you live in.
Remember, a trust doesn't offer any asset protection of its own – it
just avoids probate and gives you management options.
In order to ensure that an asset is
not considered yours, have your spouse make all of the mortgage payments
and pay the taxes on it. If your spouse is a stay at home spouse and
doesn't directly earn money, you can provide him or her money by paying a
salary.
I am paid from my company, deposit the check into an account
that is owned by my personal trust that only I sign on, and then I write
a check out of that account for 95% of the payroll amount to my wife. I
am a kept man, but over the years I have worked my way up to where I
get to keep 5% of what I make!
When my wife receives the check, she deposits it in her trust's
checking account and then pays all of the house payments and other
personal bills out of that account. If anything is left over, she does
whatever she wants with it. My wife saves it in one of her savings
accounts. All of those savings accounts (held in my wife's trust) are
outside the reach of my creditors and problems.
If the non-working spouse receives a salary and does whatever
they want with the money, the courts have held that any mortgage
payments, savings account deposits, etc., are not coming from you.
Consequently, the assets paid for by your spouse and held in his or her
trust cannot be tied back to you.
Retirement and Benefits
Retirement plans come in lots of different forms. Everybody
concentrates on retirement plans as a tax shelter – and they are great
tax shelters – but they are a problem if you want to put a ton of money
away and not pay a fortune to take care of your employees.
Retirement plans are basically 100% asset-protected, and they
grow tax-deferred. (Remember the "dollar doubled 20 times" illustration?
Tax-free or tax-deferred growth is a big deal.) The government ensures
that you can't put any money into a retirement account without paying
for all of your employees, and today the laws are very tight.
First, make sure you always fund an IRA for yourself, your
spouse, and your children. Figure out a way to get them the money that
they need to fund their IRAs. It can be a regular IRA for you and your
spouse if you are making too much money and can't meet the adjusted
gross income (AGI) requirements for a Roth IRA. Make sure your children
start a Roth IRA – they can do things with a Roth later in life,
regardless of how much money is in it. Note that the IRA has nothing to
do with your business: it is absolutely personal.
Second, maximize your "standard office" retirement plan. By including only full-time and long-term employees, you will be okay on costs. Restrict participation in the plans as much as you can under the law, and keep in mind that if you can't legally restrict an employee's participation in the retirement plan, they are probably a valuable asset to you and you should take care of them.
Third, use "non-qualified" plans. A
qualified plan is one authorized under the Employee Retirement Income
Security Act (ERISA). All of the numbered plans (401(k), etc.) are ERISA
plans, while a non-qualified plan is one that the financial industry
has created to mimic the qualified plans.
How can you make money grow tax-free or tax-deferred without
having a qualified retirement plan? You can use benefit plans, but they
are ERISA plans that must be extended to the employees. IRAs qualify,
but you can't put enough money in them through contributions. The other
option is a non-qualified plan.
The most popular non-qualified plan is a life insurance policy.
Don't check out on me here. Life insurance is a hated topic, because
inside your gut you know they are cheating you. It's true! But, there
are two reasons to own life insurance.
One reason is the death benefit. I promise you (because I've
been there) that when they walk in and say you only have a couple of
weeks left to live, you'll think first of your family and how you love
them. Next, you will think of the economic impact that your death will
have on them. Inevitably, somewhere in there you will think of the
words, "life insurance."
You need death benefits unless you are retiring and have lots of
money to see your family through. If you have financial
responsibilities for your family, you need a lot more death benefits
than you think you do. Beef up your death benefits now!
The other main reason for owning life insurance is the tax
benefits. You can make a life insurance policy absolutely mimic a Roth
IRA. Money goes in after tax, grows without a tax, and you can spend it
without a tax. There is a "cost of insurance," but if the policy is
designed right, the tax benefits will quickly overshadow the cost of
insurance.
In your gut you still know it's a bad deal. You're right!
Except… you can do it right, but it's hard. In our office, we have
studied hundreds of life insurance contracts. Our CPA is an expert in
evaluating insurance policies and contracts. You have to pick the right
company and get the appropriate contract, or a non-qualified plan will
not be that good.
The concept is: you put money into the savings portion of the
life insurance contract. You may want to use some type of a universal
life contract rather than whole life. The money grows tax-free. Then,
you borrow the money out and spend it tax-free. When you die, the death
benefit pays back all the money that you borrowed. While it all sounds
easy, keep in mind that there are many traps.
Picking the right policy for investment
options is a challenge, and assuming you get that right, getting your
insurance agent to play ball may be a big problem. When you pay an
insurance premium, some of the money has to go to death benefit coverage
– the cost of insurance – and the rest of it can go into "savings."
Basically, the agent only gets a commission for the amount that goes
into the death benefit, so where do you think your money is going to be
spent?
If the policy is designed to follow "guideline premiums," you
will put the maximum amount into the savings part of the policy as
dictated by federal law. Agents may choose not to give you guideline
premiums because they receive a low commission on this. When the life
insurance agent gives you an illustration, someplace on the example it
has to say the guideline premium amount. Your agent may not point it out
to you, but now you know to look for it.
Next, the borrowing provisions in the contract are critical. If
there is an interest rate on the borrowed money, you will lose. Your
agent will ask, "But, where else can you borrow money for only 1.5%
interest?" That is true, but remember, it's your money. You would kill
to lower your mortgage rate 1.5% since you know that, over the years,
1.5% is a huge difference on your home mortgage interest payments. Guess
what. It's the exact same thing on money borrowed from your life
insurance savings.
The policy will say the current practice is that, "We don't
charge interest." Got ya again. Fifteen years down the road, when you
want to borrow, "current practice" will be different – guaranteed. At
that point there will be nothing you can do about it. When an insurance
company needs its stock to go up, they simply raise the interest rate on
borrowed money.
You have to purchase a policy that absolutely states the
interest rate is zero – no possible changes. There are a couple of
companies that have those policies. If you get a "zero wash" policy and
guideline premium with a good company, you've almost got a Roth IRA
duplicate.
With non-qualified plans, there is no obligation to employees.
It is your policy and has nothing to do with your business. Also, there
aren't any contribution limits – we have clients who put $100,000 a year
into a life insurance (non-qualified plan) policy.
Summary
In this series of six articles, we have covered a broad range of
topics for you as a small business owner. The law touches everything
you do. You don't need to be an attorney, but you do need to know what
the basics of the law are and understand the concepts well enough to
make sure your advisors aren't leading you down the primrose path.
HBMA members tend to be busy, and they may want advisors who
they can trust to do everything for them. When you blindly trust your
advisors and ask them to set you up, you may get exactly what you asked
for – a setup. When you take your eyes off the ball, the ball will be
lost every time.
As a small business owner dealing with lucrative billing
accounts, you are in the wonderful position of having the earnings
potential to make good money. If you avoid one or two of the legal and
financial traps that so many fall into, that will be the difference in a
reasonable retirement and a great retirement and life. I really do hope
this series has helped make a difference.
Attorney
Lee R. Phillips is a nationally recognized expert in the field of
financial and estate planning. Lee is licensed to practice law before
the United States Supreme Court and also holds licenses in insurance and
securities.