What is a captive insurance company (CIC)?
Captive Insurance Companies vs. Qualified Plans
Q: What is a captive insurance company (CIC)?
A CIC is an insurance company that insures the risks of a single company (single member CIC) or a small group of companies (multi-member CIC). The owners of the CIC are usually the owners of the companies being insured by the CIC but can be owned by other people or trusts to accomplish estate planning and asset protection goals as well. A CIC is a real insurance company licensed in a jurisdiction that is favorable to the regulation and expense of operating a CIC. We use the island of St. Kitts. This country's insurance law allows for the operation of an insurance company with much lower initial capital and less on-going expense. (Note - there is no special tax benefit for the CIC being outside of the United States. The CIC will be subject to US tax law.)
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Q: Captive Insurance Companies vs. Qualified Plans
It is not uncommon for a client to ask about what the difference is between Captive Insurance Companies (“CICs”) and the better known alternative of Qualified Plans (“QPs”). The answer is that the differences are numerous and substantial, but the key differences are the following:
Contributions: Any CIC can receive any actuarially justified premium of any amount. Most Fortune 500 companies have CICs. The smaller 831(b) version of CICs can receive up to $1,200,000 in premiums per year. In contrast, many QPs (including Defined Contribution Plans such as a profit-sharing plan [even with 401(k) features] and Defined Benefit Plans) can receive only up to approximately $50,000 and $250,000 in contributions, respectively.
Investment Assets: CIC funds can be invested in prudent business projects in coordination with the insured operating entity and/or its owners. Similar QP investments would probably either disqualify the QP (a disastrous tax event) or subject the participants in any such “prohibited transaction” to severe non-deductible excise taxes and/or penalties.
Asset Protection: CICs are asset protected regardless of the amount of their funding (and receive an even greater layer of protection if owned by a properly designed trust). QPs also generally receive considerable asset protection under ERISA but IRAs are limited to $1,000,000 in creditor protection. Further, the only creditor claimant against a CIC is the insured of the CIC (which is typically the owner of the operating entity- who is usually the same as or related to the owners of the CIC).
Distributions: Distributions from a CIC can be taken at any time by the CIC owners. As “qualified dividends”, those distributions would be taxed currently at only 15%. In contrast, except for a loan up to a maximum of $50,000, all QPs severely punish withdrawals before age 59 ½ with a 10% penalty on top of ordinary income tax rates.
Liquidation: When a CIC is liquidated or sold to a third party, the smaller capital gains tax rate is owed, as compared to the higher ordinary income tax rate on cashing out a QP.
Estate Tax: Assuming the CIC is owned by trusts for your family, every premium payment to the CIC (and any asset growth within the CIC) is outside of your estate (by lowering the value of the Operating Entity). Every dollar placed into any QP or IRA (and all subsequent growth) is includable in your estate and taxable upon your death. In addition, the heirs must eventually pay income tax on the entire QP.
Summary: As compared to any QP, a CIC has a higher threshold of allowable tax deductible contributions, comparable growth possibilities for assets contributed, more investment options, superior asset protection, and a tax-advantaged way to distribute assets to the owners (while alive or post-death).
If you need additional information on the advantages offered by a CIC, please contact Webb & Graves, P.L.L.C. We will be pleased to assist you. Further, we also offer a highly valuable FAQ and a White Paper on CICs if you believe they would be of assistance. Go to www.WebbandGraves.com for further information.
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