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Filling Business Owner Financial Gaps in a Challenging Economy NAME TITLE Principal Financial Group Filling Business Owner Financial Gaps in a Challenging Economy NAME TITLE Principal Financial Group Date, 2009

While this communication may be used to promote or market a transaction or an While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements. Insurance products from the Principal Financial Group® are issued by Principal National Life Insurance Company (except in New York) and Principal Life Insurance Company, Des Moines, IA 50392. #2398032011

Agenda • • Financial Gaps in a Challenging Economy Retirement and Market Considerations Exit Agenda • • Financial Gaps in a Challenging Economy Retirement and Market Considerations Exit Planning Considerations Estate Planning Considerations

Family Business: Competing Values Family Business: Competing Values

Conflicting Values Conflicting Values

Financial Gaps for the Business Owner • • • Retirement Gap Market Gap Business Financial Gaps for the Business Owner • • • Retirement Gap Market Gap Business Value Gap Estate Gap Government Gap

The Retirement Gap filling the gap that Social Security and your qualified plan doesn’t The Retirement Gap filling the gap that Social Security and your qualified plan doesn’t cover

The Market Gap filling the investment gap that the recent market downturn has created The Market Gap filling the investment gap that the recent market downturn has created

The Business Value Gap Helping to secure the gap between your business’s fair market The Business Value Gap Helping to secure the gap between your business’s fair market value and your book value

The Estate Value Gap filling the gap in your estate plan caused by the The Estate Value Gap filling the gap in your estate plan caused by the recent market downturn

The Government Gap filling the gap in your plan caused by reduced government benefits The Government Gap filling the gap in your plan caused by reduced government benefits

Filling the Gaps • • • Retirement Gap Financial Review Market Gap Bus. Valuation Filling the Gaps • • • Retirement Gap Financial Review Market Gap Bus. Valuation Business Value Gap Buy-sell Review Estate Gap Estate Review Government Gap

Retirement and Market Gap Planning • Determining the gaps • Filling the gaps • Retirement and Market Gap Planning • Determining the gaps • Filling the gaps • Funding the gaps

Determining the Gaps • • Financial Review Business Review Estate Review Coordinating the planning Determining the Gaps • • Financial Review Business Review Estate Review Coordinating the planning team

Determining the Gaps: Key Considerations • • • Your risk profile Your continued involvement Determining the Gaps: Key Considerations • • • Your risk profile Your continued involvement Government programs Business as retirement source

Filling the Market and Retirement Gaps • • New capital Return on capital Filling Filling the Market and Retirement Gaps • • New capital Return on capital Filling with Tax Advantages Insuring the gaps

Insuring the Gaps This information is from the Principal Financial Group Replacement Ratio Calculator Insuring the Gaps This information is from the Principal Financial Group Replacement Ratio Calculator with source information from the Annual Statistical Supplements to the Social Security Bulletin (www. ssa. gov/SSA_Home. html). It is intended to demonstrate the potential impact of Social Security and 401(k) plan benefits at various income levels. For more information on your individual circumstances, please speak with your financial professional. © 2009 Principal Financial Services, Inc.

Your $2 MM is now worth $1 MM How long will it take to Your $2 MM is now worth $1 MM How long will it take to recover? Return 5% 6% 7% 8% 9% 10% 0% Tax Rate 30% Tax Rate Recovery Year 2024 2030 2021 2026 2019 2024 2018 2022 2017 2021 2019 2016

Filling the Gaps EXAMPLE: Permanent Life Insurance • Insuring the gap: Death Benefit • Filling the Gaps EXAMPLE: Permanent Life Insurance • Insuring the gap: Death Benefit • Tax Considerations – During Life – At Death • Cash Flow: policy review • Return: – Life insurance IRR – As an asset class

Filling the Gaps EXAMPLE: Permanent Life Insurance • Funding - Business Dollar versus Personal Filling the Gaps EXAMPLE: Permanent Life Insurance • Funding - Business Dollar versus Personal Dollar • Ownership – Business versus Personal • A possible solution: Bonus Plan – Principal S Owner Plus. SM – Principal LLC Bonus. SM

Principal S Owner Plus. SM 1. Owner selects an amount to contribute on an Principal S Owner Plus. SM 1. Owner selects an amount to contribute on an after-tax basis 2. Contributions are premiums for an individually owned, tax advantaged life insurance policy. Contributions can be treated as a bonus (W-2) or as dividend (K-1). 3. At retirement, the owner may access the values in the policy to supplement retirement income. 4. At death, the beneficiaries receive a tax free death benefit

Business and Estate Gaps: Owner Transition Planning • Determining the gaps • Business continuation Business and Estate Gaps: Owner Transition Planning • Determining the gaps • Business continuation and owner exit planning • Funding the gaps

Exiting Your Business Three Key Steps • Assure the Financial Survival of your Business Exiting Your Business Three Key Steps • Assure the Financial Survival of your Business … and your Family • Establish an Exit Plan, including – Valuation – Buy-Sell Review • Fund your Plan

The Sale to Income Challenge More Than Enough: Issues/Opportunities • Taxes • Wealth Preservation The Sale to Income Challenge More Than Enough: Issues/Opportunities • Taxes • Wealth Preservation • Charitable Giving Sale Too Little: Issues/ Opportunities • Cash Flow Sale Price Sale price needed to support income goal • Increase Value • Increase Return $2 MM $4 MM $6 MM Sale Price $8 MM

Business Valuation Business Valuation

How Exit? Common Techniques • Buy Sell – Stock or Assets – Cross Purchase How Exit? Common Techniques • Buy Sell – Stock or Assets – Cross Purchase or Redemption • Capital Transfers – Compensation and Benefits – ESOP – Recapitalization • Gift – Charitable – Family

Buy - Sell Techniques • Stock or Assets? • Cross Purchase A • Redemption Buy - Sell Techniques • Stock or Assets? • Cross Purchase A • Redemption B Bus A • ADVANCED: Wait-and-See, Partnership

Non Buy-Sell Example: Stay Bonus • Problem – – Family business with non-family key Non Buy-Sell Example: Stay Bonus • Problem – – Family business with non-family key employees – How keep them in the business? • Solution – Stay Bonus for non-family employees – Life Insurance funds the bonus

Funding the Exit Plan Family Owned Businesses: • • • Less than 1/3 survive Funding the Exit Plan Family Owned Businesses: • • • Less than 1/3 survive into the second generation 12% to the third 3% to the fourth generation Source: Raymond Institute/Mass. Mutual, American Family Business Survey, 2003

Sources of Funding for the Exit Plan • • Business Equity Financing Tax Benefits Sources of Funding for the Exit Plan • • Business Equity Financing Tax Benefits Insurance

EXAMPLE: Funding the Stay Bonus EXAMPLE: Funding the Stay Bonus

Estate Gap Planning • Determining the gaps • Filling the gaps • Funding the Estate Gap Planning • Determining the gaps • Filling the gaps • Funding the gaps

Estate Planning: Taxes Can be the Culprit • Capital Gains Tax – 15% • Estate Planning: Taxes Can be the Culprit • Capital Gains Tax – 15% • Alternative Minimum Tax Rate – 20% • Ordinary Income Top Tax Rate – 35% • Federal Estate Tax Rate – 45% !!

Tax Sources Income Asset Capital Asset = Subject to taxation Estate Tax Sources Income Asset Capital Asset = Subject to taxation Estate

Estate of Blount v. Commissioner, C. A. 11 - 2205 -2, 2005 • Buy Estate of Blount v. Commissioner, C. A. 11 - 2205 -2, 2005 • Buy sell agreement to redeem shares at pegged value at death • IRS ignores estate’s business valuation • Tax Court affirms IRS • Circuit Court affirms on issue of valuation • Estate value is $6. 50 MM • Must redeem at $4. 00 MM

Ten Estate Planning Mistakes • • • Too much jointly held property Leaving everything Ten Estate Planning Mistakes • • • Too much jointly held property Leaving everything to your surviving spouse Your will is not your will Improperly owned life insurance Success in wealth accumulation ≠success wealth transfer Leaving retirement plans to your children Lack of liquidity Equally inequitable Everyone must pay estate taxes No integrated estate plan

Example 1: Estate Equalization Challenge Solution • Some children are in the • Treat Example 1: Estate Equalization Challenge Solution • Some children are in the • Treat the children business; some are not equitably • Want to treat all the • Set up irrevocable trust children equally with 2 nd to Die Life Insurance policy • Want to pass on majority of the wealth • Use proceeds to provide after the second of the wealth to children not two parents die involved in the family business

Estate Equalization-Solution Estate Equalization-Solution

Example 2: Interest Only Note Challenge Solution • Parents want business to pass to Example 2: Interest Only Note Challenge Solution • Parents want business to pass to children (or key employees) • Business value is appreciating • Cost of a direct buyout is prohibitive • Sell interest in business to children for interest only note • Buyer buys life insurance on seller. At death, proceeds pay off principal on note • Only principal (not appreciation) is taxed in estate

Interest Only Note – How It Works Interest Only Note – How It Works

Bottom Line …for the Bottom Line Business Owner Bottom Line …for the Bottom Line Business Owner

Core Government Benefit Programs Under Pressure • Aging of population • Life expectancies increasing Core Government Benefit Programs Under Pressure • Aging of population • Life expectancies increasing • Social Security/Medicare/Medicaid funding concerns • Continued inflation in healthcare costs REALIZATION: Government cannot afford to provide all

The Marketplace Market Challenges • Credit Markets • Capital Markets • Globalization – the The Marketplace Market Challenges • Credit Markets • Capital Markets • Globalization – the dark side Market Opportunities • Technology potential • Post-recession growth • Globalization – the Force

“Do it for me” “Do it yourself” “Do it for me” “Do it yourself”

Help…I need somebody! Let us Help Help…I need somebody! Let us Help

Q & A ? No part of this presentation may be reproduced or used Q & A ? No part of this presentation may be reproduced or used in any form or by any means, electronic or mechanical, including photocopying or recording, or by any information storage and retrieval system, without prior written permission from the Principal Financial Group®. Copyright © 2009 Principal Financial Services, Inc.