Filling Business Owner Financial Gaps

in a Challenging Economy

NAMETITLE

Principal Financial Group

Date, 2009

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products from the Principal Financial Group® are issued by Principal National Life Insurance Company (except in New York) and Principal Life Insurance Company, Des Moines, IA 50392.

#2398032011

Agenda

• Financial Gaps in a Challenging Economy

• Retirement and Market Considerations

• Exit Planning Considerations

• Estate Planning Considerations

Family Business:

Competing Values

Conflicting Values

Financial Gaps for the Business Owner

• Retirement Gap

• Market Gap

• Business Value Gap

• Estate Gap

• Government Gap

The Retirement Gapfilling the gap that Social Security and your qualified plan doesn’t cover

The Market Gapfilling the investment gap that the recent market downturn has created

The Business Value GapHelping to secure the gap between your business’s

fair market value and your book value

The Estate Value Gapfilling the gap in your estate plan caused by the recent market downturn

The Government Gap filling the gap in your plan caused by reduced government benefits

Filling the Gaps

• Retirement Gap

• Market Gap

• Business Value Gap

• Estate Gap

• Government Gap

Financial Review

Bus. ValuationBuy-sell Review

Estate Review

Retirement and Market Gap Planning

• Determining the gaps• Filling the gaps• Funding the gaps

Determining the Gaps

• Financial Review

• Business Review

• Estate Review

• Coordinating the planning team

Determining the Gaps:

Key Considerations

• Your risk profile

• Your continued involvement

• Government programs

• Business programs

• Business as retirement source

Filling the Market and Retirement Gaps

• New capital

• Return on capital

• Filling with Tax Advantages

• Insuring the gaps

Insuring the Gaps

This information is from the Principal Financial Group Replacement Ratio Calculator with source information from the Annual Statistical Supplements to the Social Security Bulletin (www.ssa.gov/SSA_Home.html). It is intended to demonstrate the potential impact of Social Security and 401(k) plan benefits at various income levels. For more information on your individual circumstances, please speak with your financial professional. © 2009 Principal Financial Services, Inc.

Your $2MM is now worth $1MM

How long will it take to recover?

Return 0% Tax Rate

5% 2024

  6% 2021

  7% 2019

  8% 2018

  9% 2017

10% 2016

30% Tax Rate

2030

 2026

 2024

 2022

 2021

2019

Recovery Year

Filling the Gaps EXAMPLE: Permanent Life Insurance

• Insuring the gap: Death Benefit

• Tax Considerations– During Life– At Death

• Cash Flow: policy review

• Return: – Life insurance IRR– As an asset class

Filling the Gaps EXAMPLE:

Permanent Life Insurance

• Funding - Business Dollar versus Personal Dollar

• Ownership – Business versus Personal

• A possible solution: Bonus Plan– Principal S Owner PlusSM

– Principal LLC BonusSM

1. Owner selects an amount to contribute on an after-tax basis2. Contributions are premiums for an individually owned, tax

advantaged life insurance policy. Contributions can be treated as a bonus (W-2) or as dividend (K-1).

3. At retirement, the owner may access the values in the policy to supplement retirement income.

4. At death, the beneficiaries receive a tax free death benefit

Principal S Owner PlusSM

Business and Estate Gaps: Owner Transition Planning

• Determining the gaps• Business continuation and owner exit planning• Funding the gaps

Exiting Your Business

Three Key Steps

• Assure the Financial Survival of your Business … and your Family

• Establish an Exit Plan, including– Valuation– Buy-Sell Review

• Fund your Plan

Sale Too Little:Opportunities

• Cash Flow

• Increase Value

• Increase Return

More Than Enough:

• Taxes

• Wealth Preservation

• Charitable Giving

The Sale to Income Challenge

Sale Price

Issues/

Issues/Opportunities

Sale price needed to support income goal

$4MM $6MM $8MM

Sale Price

$2MM

Business Valuation

How Exit?

Common Techniques• Buy Sell

– Stock or Assets– Cross Purchase or Redemption

• Capital Transfers– Compensation and Benefits – ESOP– Recapitalization

• Gift– Charitable– Family

Buy - Sell Techniques

• Stock or Assets? • Cross Purchase• Redemption

• ADVANCED: Wait-and-See, Partnership

A B

Bus

A

Non Buy-Sell Example: Stay Bonus

• Problem – – Family business with non-family key employees

– How keep them in the business?

• Solution– Stay Bonus for non-family employees– Life Insurance funds the bonus

Funding the Exit Plan

Family Owned Businesses:• Less than 1/3 survive into the second

generation • 12% to the third• 3% to the fourth generation

Source: Raymond Institute/MassMutual, American Family Business Survey, 2003

Sources of Funding for the Exit Plan

• Business Equity

• Financing

• Tax Benefits

• Insurance

EXAMPLE:

Funding the Stay Bonus

Estate Gap Planning

• Determining the gaps• Filling the gaps• Funding the gaps

Estate Planning:

Taxes Can be the Culprit

• Capital Gains Tax – 15%

• Alternative Minimum Tax Rate – 20%

• Ordinary Income Top Tax Rate – 35%

• Federal Estate Tax Rate – 45% !!

Tax Sources

IncomeAsset

CapitalAsset

Estate

= Subject to taxation

Estate of Blount v. Commissioner,C.A. 11- 2205-2, 2005

• Buy sell agreement to redeem shares at pegged value at death

• IRS ignores estate’s business valuation

• Tax Court affirms IRS

• Circuit Court affirms on issue of valuation• Estate value is $6.50 MM

• Must redeem at $4.00MM

Ten Estate Planning Mistakes

• Too much jointly held property

• Leaving everything to your surviving spouse

• Your will is not your will

• Improperly owned life insurance

• Success in wealth accumulation ≠success wealth transfer

• Leaving retirement plans to your children

• Lack of liquidity

• Equally inequitable

• Everyone must pay estate taxes

• No integrated estate plan

Example 1: Estate Equalization

Challenge

• Some children are in the business; some are not

• Want to treat all the children equally

• Want to pass on majority of the wealth after the second of the two parents die

Solution

• Treat the children equitably

• Set up irrevocable trust with 2nd to Die Life Insurance policy

• Use proceeds to provide wealth to children not involved in the family business

Estate Equalization-Solution

Example 2: Interest Only Note

Challenge

• Parents want business to pass to children (or key employees)

• Business value is appreciating

• Cost of a direct buyout is prohibitive

Solution

• Sell interest in business to children for interest only note

• Buyer buys life insurance on seller. At death, proceeds pay off principal on note

• Only principal (not appreciation) is taxed in estate

Interest Only Note – How It Works

Bottom Line

…for the Bottom Line

Business Owner

•Aging of population

•Life expectancies increasing

•Social Security/Medicare/Medicaid funding concerns

•Continued inflation in healthcare costs

REALIZATION: Government cannot afford to provide all

Core Government Benefit Programs Under Pressure

The Marketplace

Market Challenges

• Credit Markets• Capital Markets • Globalization –

the dark side

Market Opportunities

• Technology potential • Post-recession

growth• Globalization –

the Force

“Do it for me” “Do it yourself”

Help…I need somebody!

Let us Help

Q & A ?

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Copyright ©2009 Principal Financial Services, Inc.