Captive Insurance: As Good as it Sounds?
Contents
- What is Captive Insurance, Really?
- Why do businesses set up Captive Insurance?
- Does Captive Insurance offer tax benefits?
- Who Really Needs Captive Insurance?
- Alternatives to Captive Insurance
- Option #1: Solo 401(k)
- Option #2: Tax-Free and Tax-Deferred Insurance
- Option #3: Go offshore and enjoy a big tax break
- Captive Insurance and Your Plan B: Does it fit?
Over the years, I’ve heard some “great in theory, not in practice” planning ideas. Many are taken from a proven tool and warped into something that just doesn’t work well anymore. Captive Insurance is one of those things.
In principle, it’s a way to legally save yourself a lot of taxes while building a nest egg that benefits from strong asset protection. In practice, it’s a tax shelter that the IRS really doesn’t like.
Yes, there is a place for it. But there’s also a good chance that your best Plan B doesn’t need it. There are better options out there.
In this article, I’ll give you some perspective on what Captive Insurance is, how it’s supposed to be used, when it might make sense for your unique situation, and alternatives to captive insurance that are a better fit for most clients.
What is Captive Insurance, Really?
Captive insurance involves setting up separate company that’s fully owned by a parent company. That separate company handles the risks of the parent company or its related entities by taking in premiums from the parent (or related companies), investing those premiums, and standing ready to pay out a claim as needed.
Basically, it’s your own private insurance company; a “captive” to the parent business.
Why do businesses set up Captive Insurance?
There are three main reasons:
- #1: Sometimes, the parent company just can’t find an external insurance firm that offers the right coverage for certain business risks. This is especially true in newer industries that regular insurance companies don’t understand. And businesses of all types are finding it increasingly difficult to cover risks like environmental liability, extreme weather events, and cyberattacks.
- #2: Sometimes the parent company can get a policy, but the perceived risk is so high that the premiums charged by a regular insurance company are just too high. It’s cheaper for the parent company to create their own captive insurance company.
- #3: Putting assets into a captive insurance company can be a useful asset protection strategy. This can be quite useful for parent companies in high-risk businesses where regular insurance is already hard to get.
Does Captive Insurance offer tax benefits?
Yes, there can be tax benefits, as many an armchair expert and offshore YouTuber have promised. But it’s a lot more nuanced than they often make it out to be.
Premiums paid into a captive can be written off by the parent. That lowers taxable income at the parent level, meaning a lower tax bill to owners in the year the premium is paid. Those premiums can be invested and earn a return.
In addition, the captive isn’t taxed on the premium payments. But it will still be on the hook for regular taxes on all income or gains from those investments. It’s not like other tax deferral strategies like a PPLI or retirement plans that shelter income or gains until they are removed from the structure.
Still, that ability to write off the premium at the parent level has made them quite attractive in certain cases.
In fact, they’ve become so popular, that the IRS is not pleased. Unlike other well-known tax deferral strategies like retirement accounts, life insurance, or annuities, they’ve started to make life for companies that try to use captives solely as a tax dodge quite uncomfortable.
Who Really Needs Captive Insurance?
Answer the following questions Yes or No.
Do you have an existing company?
Do your annual insurance premiums exceed $500,000?
Is your business generating at least $10 million in annual revenue?
Do you have a stable and predictable cash flow?
Is your company in a business that’s considered “high risk” by insurance companies?
Is your company in an industry that’s poorly understood by insurance companies?
Is your company in an industry that insurance companies don’t like (e.g. adult services, gambling)?
Is your business subject to frequent or large claims that could be better managed internally?
Do you have access to the necessary expertise or advisors to help manage a captive effectively?
Are you willing to commit to the regulatory and administrative requirements of operating a captive?
If you answered yes to a lot of these questions, then it might make sense to get captive insurance. But if not, there could be better options.
Alternatives to Captive Insurance
If you don’t have a business or you run a small business that doesn’t justify a captive insurance company, there are other options for tax deferral or tax-free growth.
Option #1: Solo 401(k)
The simplest (and arguably most boring) are retirement accounts. If you happen to own a small business that is operated by you (and maybe your spouse), a solo 401(k) is well worth considering. They’re quite flexible and easy to administer.
(In fact, we’ve recommended them for so long that we’re now able to set up and manage them for clients. Feel free to get in touch if you’re interested in one.)
Option #2: Tax-Free and Tax-Deferred Insurance
Insurance is another area well worth a look. Private Placement Life Insurance (PPLI) and Private Placement Variable Annuities (PPVA) are powerful tools to quickly build a big nest egg because money in the policy can grow without being taxed.
You also get a lot of flexibility in how you can invest. For our clients, that often means moving money internationally, but it works just as well for domestic options too.
And in the case of PPLI, you or your heirs will never have to pay tax. With a PPVA, the tax is deferred until the money is pulled out of the policy.
(We’re able to assist clients with PPLI and PPVA insurance as well. Please get in touch for more information.)
Option #3: Go offshore and enjoy a big tax break
If you have a small business you can run from a laptop, or you can get a job internationally, you can move overseas full time and cut your tax bill with the Foreign Earned Income Exclusion.
As with any government program, you will have to follow certain rules to qualify. In return, the first $126,500 you earn abroad each year (2024 limit, adjusted annually) is tax-free to Uncle Sam.
(Here’s a full primer on the Foreign Earned Income Exclusion if you’d like to learn more.)
Captive Insurance and Your Plan B: Does it fit?
Not for most people in most cases.
It certainly sounds attractive but there are better options available.
More importantly, though, any tool you use needs to fit into the larger picture. A good Plan B considers how you make your money and how you build on your savings. It looks at how you can legally reduce your taxes. And it reviews the best structures, residencies, and second citizenships that make sense for you.
All of this is driven by what you ultimately want to achieve.
Because the truth is, there’s no best anything. There’s only what’s best for you.
If you’re interested in seeing whether we can help you build your best Plan B, feel free to book in a free, no-obligation call with one of our Associates.
About The Author
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We have 40+ years experience helping Americans move, live and invest internationally…
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We have 40+ years experience helping Americans move, live and invest internationally…
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