Attorney Fee Deferral Programs
By Daniel J. Alvarez, J.D. and Anthony F. Prieto, Jr., CFP®
Due to the contingent nature of compensation as a plaintiff lawyer, unique retirement planning options exist especially for you. Below we compare and contrast traditional small business retirement plans with some of the unique tax deferred planning options available when collecting a contingent fee.
The following are common advantages to deferral in general:
- Creating an automatic investment program to help augment your retirement
- The possibility of paying less tax on the withdrawal than the current tax rate
- Potentially manipulating tax brackets during the deferral years and the withdrawals years
- Earning interest on money that would have gone directly to your immediate tax burden (investing 100% instead of 60%)
Given these obvious advantages, which of the following deferral options or combination will achieve your goals? The information below may be helpful in determining which plan or combination of plans makes the most fiscal sense for you.
Traditional Small Business Retirement Plans
401(k)’s, Defined Benefit Plans, Profit Sharing, SEP IRAs and Simple IRAs are a few that would fall under the traditional options. These plans allow employees/owners to contribute funds on a pre-tax basis into the plan. The plan typically has a myriad of investment options to consider. All taxes are deferred until the funds are withdrawn.
Pros:
- Easy to install.
- Each Employee/Owner makes independent deferrals and investments.
Cons:
- The plans typically have low limits ($25k or less).
- Most small business plans require the employer match employee contributions.
- These plans are typically subject to withdrawal penalties before Age 59.5 and required mandatory withdrawals beginning at Age 70.5.
Attorney Fee Structured Settlement Plans
Attorneys are allowed to defer their fees into structured settlement annuities similar to those that are used for planning purposes with injury victim clients. The fee structure is not tax free but is instead tax deferred. Taxes are not recognized until the year in which payments from the fee structure are received. For example, an attorney can earn a $250,000 fee in 2014 but set up a fee structure with future periodic payments from 2020 to 2030. There would be no taxable income in 2014 and tax would only be due each year that money is paid out from the fee structure during the years 2020 to 2030.
Pros:
- Easy to Use.
- No Investment Risk.
- Unlimited Deferral Amounts.
- Non-marital Asset. No Early Withdrawal Tax Penalties.
- Ability to Create a Lifetime Income.
Cons:
- Plan cannot be changed after the release is signed (no acceleration or deceleration of payments).
- Fixed Investment Option Only (bond like returns).
- Defendant Cooperation and Required Language in the Release.
Alternative Fee Deferral Programs
Several new alternatives have popped up in the marketplace over the last few years that rely on the same premise and tax case law as the Attorney Fee Structured Settlement. The two that are most commonplace are: 1. Offshore Assignment Companies and 2. Deferred Compensation Programs.
1. Offshore Assignment Company (Non-Insurance Partners) – They allow the attorney to defer the fee into the Assignment Company that then invests the proceeds through a variety of investment portfolios. Through the use of the non-qualified assignment, you can unleash the power of deferral utilizing pre-tax dollars to generate tax-deferred cash flows.
Pros
- Variety of Investment Options.
- Unlimited Deferral Amounts.
- Non-marital Asset.
- No Early Withdrawal Tax Penalties.
Cons
- Plan cannot be changed after the release is signed (No acceleration or deceleration of payments).
- Complex Investment Program involving Offshore Assignments.
- Defendant Cooperation and Required Language in the Release.
2. The Deferred Compensation program is done through similar mechanics as the other deferred fee options. The main difference is in the funds not having offshore involvement and withdrawal mechanics. This type of program allows you to invest pre-tax, tax-deferred in the investments of your choosing, and to control the timing of benefits and, therefore, of taxation. It is like a super 401(k) with no limits on contributions or penalties on withdrawals.
Pros
- Variety of Investment Options.
- Unlimited Deferral Amounts.
- No Early Withdrawal Tax Penalties.
- Withdrawal Rights can be Deferred.
Cons
- Complex Investment Program for Highly Qualified Investors.
- Coordination with Client and Defendant Required.
As this article points out, there are pros and cons to each alternative. Each attorney should seek out a qualified planner and tax professional to help them navigate the options. In all probability, the best option is a combination of the programs. A fixed income component is a wise piece of any diverse investment portfolio. Plantiff attorneys should carefully consider whether adding fixed income pre-tax makes the most sense for their financial objectives.
Please contact Synergy for more information on utilizing these unique solutions.
