November 17, 2019 marks the one-year anniversary of my Dad's (Willy Wolfgang Nowotny) passing. The natural instinct is to be sad, but I choose to remember his life focusing on where he started and where he ended up. My Dad was from a small town in former East Germany about a mile from the Polish and Czech borders on the edge of the former Sudetenland. He came to the U.S. in 1952 as a refugee sponsored by a former Army Chaplain. After watching the guards at the border for two weeks, he made his escape to West Germany and freedom swimming across a river. He was drafted into Uncle Sam's Army in 1953. This was not "Easy Street" right after World War with a thick German accent and World War II veteran NC0s. After the Army, he worked for the federal government and applied for a job in the Panama Canal Zone where he had a fine career as a civil servant. By my age, he was comfortably retired traveling the World. He managed to visit every continent. While he never liked to talk about his experiences growing up during the War or East Germany after the War, he made up for it later in life for the benefit of his grandchildren. He was another American Dream success story which is something only made in American and never to be stolen and replicated by anyone else. Like many immigrants, he had the courage to risk his life and leave behind everything he knew and loved for the potential of a better life. This is the life only eagles dare!
This blog addresses the combination of the powerful Malta Pension Plan and a Loan Method Split Dollar Arrangement. It is a tax combination of a tax deferral strategy that migrates deferred dollars into tax-free dollars. Watch, listen and learn!
The Malta Pension Plan
I have written extensively on Malta Pension Plans ("Plan"). The Plan has many similarities to a Roth IRA except that the Plan has no contribution limits and is not restricted to cash contributions. A high net worth taxpayer can contribute appreciated assets to the Plan without triggering taxation on the contribution. The investment advisor within the Plan can sell appreciated capital assets within the Plan without taxation. The investment earnings within the Plan can be reinvested within the Plan and accrue on a tax-deferred basis. The Plan offers the participant various methods of distributing tax-deferred benefits on a mostly tax-free basis like a Roth IRA. The Plan offers a participant who is at least age 50 to distribute up to 30 percent of the account value on a tax-free basis. The Plan offers the participant the ability to take additional lump sum distributions up to 50 percent of the account value, three years after the lump sum distribution and every year thereafter. The Plan may always make taxable distributions to the participant.
The inevitable tax problem of a deferred compensation asset is that it is ultimately subject to income and estate taxation where applicable. In the Plan, appreciated assets at the time of the participant's death are subject to a one-time mark-to-market tax under IRC Sec 684 at the participant’s death. The tax basis of Plan assets is increased by the amount of taxes paid under IRC Sec 684. The Plan death benefit to beneficiaries receives tax-free treatment. A participant subject to estate taxation also has this tax to deal with. The combination of both taxes should get the client's attention. The other obvious problem is that the law today may not be the law tomorrow. As a consequence, it is difficult to leave all the eggs in one planning basket. The planning consideration is to identify an exit strategy to migrate assets from the Plan tax efficiently. Combining MPP planning with Split Dollar life insurance creates an opportunity to convert tax deferred dollars into tax-free dollars with respect to income and future estate taxation.
Summary
The Malta Pension Plan is an excellent planning strategy that provides Roth-like benefits without a contribution limit and the restriction to make contributions in cash. The continuation of the U.S.-Malta Income Tax Treaty like life itself is uncertain. The planning suggestion is to convert tax-deferred dollars into tax-free dollars by adding a Split Dollar arrangement into the planning. Tax deferred dollars are extended to the client's family trust as a loan in a Loan Method Split Dollar arrangement to purchase Private Placement Life Insurance (PPLI). The repositioned assets will grow income and estate tax-free outside of the reach of personal and business creditors with the participant as an income beneficiary of the Trust during his lifetime. This is the next building block in Malta Pension Planning.