The attorney never takes possession of the money. If he or she did, it would be taxed. While the money is held in the trust, the financial advisor manages the investments as the client wants. When distributions start, the third-party firm provides an IRS 1099 form to the attorney and his advisor for tax purposes each year, McCann said.
Using the tax code deferral strategy rather than an annuity to put money aside gives the client more flexibility in how the money is invested and withdrawn.
“This gives the person earning the money the chance to invest it as he or she wants with the guidance of their advisor, as permitted by the various deferred compensation plan administrators,” McCann says. “When the money is withdrawn after the recipient retires, he or she will probably be in a lower tax bracket than when the person is in peak earning years, therefore income will be taxed at a lower rate.”
But the money does not have to be used for retirement. It can also be used for a law firm’s operating expenses or other financial needs, McCann said.
“For our clients, we look at the planning process as climbing a mountain,” McCann says. “That is the accumulation phase. Then we get them down the mountain during retirement.”
McCann uses a hypothetical example to show how attorneys can realize savings. Take a lawyer who gets paid a contingency fee of $1 million after several years of work on a case. During the time working on the case, the lawyer did not get paid. Yet he or she could owe nearly $450,000 in income taxes on the contingency fee alone and be left with only $550,000 to invest—which is then taxed as it grows.
If the tax is deferred under the IRS tax rule, on the other hand, the $1 million can be invested, and the taxes can be paid over a period of years, possibly when the attorney is in a much lower tax bracket.
Under the rule, lump sum payments can be laddered to pay out at different times.
“This is not a new strategy, but a lot of attorneys are not aware of the possibility to defer payments,” McCann says. “Another of our prospective clients didn’t believe me at first because he thought it sounded too good to be true.” With an active manager, the client can select the way he wants to invest the money.
“Educating clients to this strategy can be a differentiator for a firm,” he adds. “This first client opened the way for our firm to work with other lawyers, so it has helped us as we continue to expand our business.” Crestview now works with several attorneys at different firms.
McCann says it’s important for advisors to open discovery talks with clients to uncover these types of opportunities—to have conversations with high-net-worth families that involve teams of investment, legal and tax professionals and determine what steps should be taken now and throughout the year to keep taxes at a minimum. There are a lot of planning strategies available, and it’s important for advisors to keep engaging with families.