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# Example 1

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Stacey, Cooper, and Nathan each own one-third of the outstanding stock of Theatrical Supplies, Incorporated, a small supplier of Broadway costumes. Stacey (age 45), the CEO of the company, anticipates the business having a net income of about \$1,500,000 in 2001. This is about the same as past years.

In past years, the accountant has had the business pay a “bonus” to the three owners that approximates the corporations earnings; thereby, avoiding the “double” tax that is associated with C-corporations.

Because Stacey requires about \$300,000 of annual income to maintain her current standard of living, she saves any income in excess of \$300,000 for her retirement. She hopes to save enough to retire in about 15 years.

If the corporation paid each owner a bonus of \$500,000 (i.e., one-third of \$1,500,000), Stacey would have \$200,000 (before taxes) to save for her retirement. This \$200,000 would be taxed at the top federal marginal income tax rate of 39.6%. Stacey is also subject to a Massachusetts state marginal income tax of 6%. After tax, she sees only about \$108,800 of the \$200,000 that she does not need for current living expenses.

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Assuming that she was to invest this \$108,800 for retirement each year and earn a gross return of 10% and a net return of 9.02%, she would have \$6,081,931 at retirement in 15 years. If this amount continued to earn 9.02% after-tax, Stacey could amortize this amount and have an income stream of \$692,908 for 15 years after retirement.

Alternatively, Theatrical Supplies Inc. could offer Stacey a non-qualified deferred compensation plan that would allow this \$200,000 to remain in the business each year. Although the corporation will not get a deduction for the \$200,000 in 2001, it should receive a deduction for the deferred compensation when paid.

Because the cash value of a life insurance contract grows income tax-deferred, the corporation could decide to invest the \$200,000 in a variable life insurance contract. Assuming the policy earns 10% gross (and 9.02% net), the company will have \$9,369,608 in policy cash value in 15 years.

The company could pay Stacey an annual amount of \$1,045,645 from the policy cash value for 15 years after retirement.

Reproduced from National Underwriter Life & Health/Financial Services Edition, June 11, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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