Restricted Property Trust: Examining the Pros & Cons [Top Strategies]


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Restricted Property Trusts (or RPTs) are an excellent planning tool for many business owners. Unfortunately, very few are aware that the strategy even exists.

An RPT allows for a net 70% tax deduction for all contributions during the term. These contributions will also grow tax deferred.

In this post, we will discuss the pros and cons. We will also run through client scenarios to take a look at the possible outcomes during the initial period. Let’s jump in.

What are the Pros?

Take a look at the pros and advantages in the table below:

Tax AdvantagesThe S-Corp or C-Corp can deduct 100% of the contribution, while the owner-employee must claim 30% as income. The net effect is a 70% tax deduction.
Impact on Qualified PlansThe RPT is not a retirement structure. As such, it does not fall under the testing guidelines associated with qualified plans, like 401(k)s and cash balance plans. Contributions made have no impact on retirement plan contributions.
Flexible Contribution LevelThe minimum RPT funding is $50,000 and there is no maximum. However, they do fall under the “reasonable compensation” rules. CPAs are very familiar with these rules and can work with clients to craft the correct compensation levels.
Entity StructureThese structures are available to S-Corps, C-Corps, and partnership entity structures. Most high income clients will have S-Corps, so the structure is available to most companies. It is important to note that these plans do not work for sole proprietors. So if you file a Schedule C with your personal tax return, you will have to look at a different tax planning strategy.
Asset ProtectionBecause the assets contributed to the trust are held within an insurance policy, the owner receives full asset protection from creditors. This can appeal to business owners in high risk industries and those with large estates.
Tax-Free GrowthBecause the assets are held within a life insurance policy, any growth is tax free within the policy.

What are the Cons?

While the advantages are clear, you need to make sure that you consider the downsides.

Entity RestrictionWhile these structures make sense for most entity structures, they do not work for sole proprietors. An interested business owner certainly can change their entity structure (most like to an S-Corp) in order to qualify.
Minimum TermThere is a minimum term commitment of 5 years. The plans are typically established with a 10 year term and a 5 year out.
Minimum ContributionsThe minimum annual funding is $50,000 per year. These plans do not make sense for anybody looking for small contributions.
Lower ReturnsSince the funds reside in an insurance policy, the investment returns are very conservative. So make sure that you have offsetting high risk exposure in qualified retirement plans and after-tax funds.

Client Scenarios

When a client is considering setting up an RPT, I often mention that they should look closely at how the plan may play out. If you’re comfortable with all the scenarios, specifically the downside, then the upside will itself. So let’s discuss the potential outcome in different scenarios if a client sets up an RPT.

Remember, we’ve got to get through the first five years of funding. So that’s where the risk lies.

So what can happen during those five years, and what are the results? I will take a look now.

The owner dies within five years

While this is an unlikely scenario and not good for the owner, it is a financial windfall. The owner can still claim the net 70% tax deduction for the contributions, and the insurance premium would be paid to the spouse or other beneficiaries.

In the unlikely event, this happens, this is a home run from a tax and financial planning standpoint.

The owner is unable to make the minimum funding during the five-year term

This is why making sure the owner has adequate cash flow for the next five years makes a lot of sense. Suppose the owner Is unable or unwilling to make the required contributions during the term. In that case, the policy will lapse, and all the funds held within the trust will be distributed to the designated charity. The owner is still eligible for all the tax deductions on contributions before termination.

This is the worst-case scenario. However, if someone is it supports a specific charity and can use this as a funding mechanism to make those contributions, it lessens the pain. But certainly, this is the biggest downside.

The owner pays the policy through the initial five-year term

This is the most likely scenario. At this point, the owner can elect to distribute the policy out of the trust and take it over to themselves personally. They may also continue with a successive five-year period of time.

In either case, they will earn the benefits of this through the specified period.

Conclusion

At the end of the day, the pros and cons speak for themselves. Make sure you closely examine them with your CPA and financial advisor.

Don’t forget to walk through the various outcomes. This allows you to quantify your downside and recognize your worst case scenario. Hopefully, a plan will work for you!

Paul Sundin

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