The Restricted Property Trust was created to help high-income earning business owners reduce income taxes and grow assets with sizable pre-tax contributions, tax-deferred accumulation, and tax-advantaged distribution.
The Restricted Property Trust is gaining momentum as the vehicle of choice for high-income business owners to protect their income and grow their assets.
You may have heard about it and wondered if it was too good to be true. We’re here to tell you why it could be the game changer you’re looking for.
But…it’s NOT for everyone, and we’re going to take a look at why.
What Is a Restricted Property Trust?
A Restricted Property Trust is designed to help business owners, physician groups, attorneys, athletes, and entertainers mitigate income tax. The main objective of a Restricted Property Trust is long-term, non-taxable cash growth and cash flow using a conservative asset class.
An RPT can be established by an S Corporation, C Corporation, LLC, or Partnership. It cannot be established by a sole proprietorship or an entity taxed as a sole proprietorship.
Just to be clear, a Restricted Property Trust is not a qualified plan. This means contributions to an RPT do not impact contributions to any other qualified plan you might be making contributions to (e.g. 401(k), Profit Sharing Plan, Defined Benefit Plan, etc.).
An RPT may be used exclusively to benefit the owner(s) of a company. Each participant can choose their own level of contribution, independent of what other participants choose to contribute.
The annual RPT contributions by a business are fully deductible to the employer and around 30% of the contribution is included in the participant’s current taxable income.
Am I Eligible for an RPT?
So, as we said, a Restricted Property Trust is not for everyone. There are certain criteria to consider before establishing an RPT. To be eligible for an RPT you need to meet the following:
- Established by a business entity other than a sole proprietor or entity taxed as a sole proprietor
- Do not have to include any benefits to establish
- Are able to contribute $50,000 or more per year for a minimum of 5-years
If you are unsure of your ability to meet the minimum payments for at least 5 years, then this is not the vehicle for you.
How Does a Restricted Property Trust Work?
So far, so good? Let’s learn more about how an RPT works.
The RPT contributions fund a life insurance policy for the participant(s).
The business pays a 100% deductible contribution to the trust on behalf of each of the participants in the plan. Around 30% of this contribution is classed as a taxable income to the participant.
Because a whole life insurance policy is being used to fund the RPT, the cash value growth is tax-deferred.
When funding is completed the insurance policy transfers from the trust to the individual participant(s). A withdrawal is made from the policy to pay any taxes owed when the policy is distributed.
Once the policy has been distributed from the trust, the participant is able to access tax-exempt cash flow in addition to maintaining the death benefit for named beneficiaries.
The reason that an RPT is not considered to be deferred compensation is that it is not subject to 409A and has a “substantial risk of forfeiture”. An RPT meets this requirement in 3 ways:
- The plan must be funded for at least 5 years (all extensions must be in 5-year increments)
- Funds are not accessible until the policy is distributed from the trust
- If funds are not contributed in the determined amount each year, the contributed funds are forfeited to a public charity
It is these three features that meet the IRS terms for “substantial risk of forfeiture”.
What Are the Benefits of a Restricted Property Trust?
- High-income earning business owners are able to make significant contributions provided a business need for life insurance coverage exists and the amount of coverage needed is sufficient enough to maintain the desired level of contribution
- The plan does not affect contribution to any qualified plans so you can continue to contribute to both without any impact on the other
- 100% tax-deductible contribution to your business
- The assets are protected from creditors while the plan is being funded
- A Restricted Property Trust may provide earnings of 8% or more when compared to other fixed-income vehicles
What Else Do You Need to Know about RPTs?
Well, just like any other asset or tax deduction vehicle, you need to do your own due-diligence. Whether or not the RPT is a good fit for your business depends on your unique circumstances and cash flow.
That said, if you meet the requirements for a Restricted Property trust and you earn over $500,000 per year then the RPT is a strong option. Especially given recent talk of finding ways to increase the income tax for the highest bracket.
Finally, despite being a conservative asset class the returns are promising and the economic benefits of the plan are clear.
For more information on Restricted Property Trusts or to schedule a consultation, please contact us.
Or, you can take a look at our comparison article on RPT vs Taxable Investments.
