Are all of your retirement “eggs” in one “savings basket”? If you’re part of the 59% of Americans who have a retirement savings plan, chances are you have a 401(k) or IRA. These retirement plans can come with numerous benefits, such as employer matching, tax-free contributions, or tax-deferred growth. However, many taxpayers go all-in on these accounts without ever considering the pros and cons. While retirement plans do come with tax benefits, they also come with ticking time bombs. One problem is that most retirement plans defer taxes rather than actually reducing them. This can lead to a catastrophic tax event down the road, especially if you end up in a higher tax bracket during your retirement years.
What many taxpayers don’t realize is that traditional retirement accounts are not the only option. Especially if you are a small business owner, you may already be well-positioned to implement alternative retirement savings strategies that come with tax advantages, fewer restrictions, and more control over when you can access your money. The first of these strategies that we’ll explore is the use of captive insurance.
What is Captive Insurance?
Captive insurance provides a way for a company to insure itself. Instead of paying a third-party, the company underwrites its own insurance. What’s the difference between captive insurance and simply setting aside an emergency fund for your company? The tax benefits. The main one is that you are allowed to deduct the amount you pay in premiums to that captive insurance company.
The main benefits are threefold:
1. Your main business gets a tax deduction for paying premiums.
2. The premiums are paid to a captive insurance company that you own.
3. Instead of absorbing 100% of the risk as you would with an emergency fund, you enjoy lower risk and lower costs if an emergency occurs as you would with a regular insurer.
How Can You Benefit from Captive Insurance?
So you’re interested in captive insurance. How do you get started? Step one is to establish a property and casualty insurance company that is owned by the company it insures. Step two is for the captive insurance company and the main business to interact in the same way you would with any insurer. The business pays premiums and gets insurance coverage in return. Keep in mind that those premiums are being paid to a company you own—so it’s like moving money from one pocket to the other.
Here’s another benefit: As long as the insurance company’s premium income remains below a certain threshold, the IRS says you do not have to pay tax on that income. This happens through an “831(b) election.” For 2025, the income threshold is $2.85 million. While premium income can be tax-exempt, any investment income is not. Investment returns earned by the insurance company will likely be taxed at the 21% corporate tax rate. This may be worth the taxes, since you can invest in a wide-range of options like high yield savings accounts, cryptocurrency, exchange-traded funds, or other investment vehicles.
When that income is distributed to the owners, it will be taxed at a capital gains rate, which could be 0%, 15%, or 20%, plus a potential 3.8% surtax if you’re over the threshold for net investment income tax. That means the maximum combined tax rate is 23.8%, a lower rate than you would see for traditional retirement plan distributions.
What’s more, you have much more control over the timing of those distributions. Captive insurance companies are not subject to required minimum distributions, unlike an IRA or 401(k) account. This gives you the option to take those distributions when your tax rate will be at its lowest. You also have control over the amount you take out, so you can be strategic about staying beneath the threshold to secure that 0% long-term capital gains tax rate.
A few other factors that make captive insurance more flexible than a retirement savings account: you do not need to match employee contributions, you do not need to conduct discrimination testing, and there is no “use it or lose it” rule. If you can’t afford the insurance one year, you simply don’t buy it.
What Are the Limitations of Captive Insurance?
Of course, the captive insurance company does face certain restrictions. For one, the company must keep enough in liquid assets (meaning they can quickly and easily be converted to cash) to pay any claims. Since it’s all your money, you would be paying for that claim, anyway! The amount you need in liquid funds is determined by the state the business is formed in—what do they need to see to consider your company a bonafide insurance company? If you don’t pass the tests, your premiums will not be eligible for the tax deduction.
To be considered “bonafide,” the main business must have legitimate risk—in other words, a real reason why you would need captive insurance. Check the IRS rules on “ordinary and necessary” expenses to make sure you fit the requirements. You can find this in IRC Section 263 on capital expenditures. If you don’t meet the rules, once again, your premium payments are not eligible for the tax deduction.
One major disadvantage with the captive insurance company is that it does not offer deferred tax-free growth. This is why the best next step is to talk to a Certified Tax Planner about what combination of traditional retirement plans and alternative retirement strategies could work for you.
With the captive insurance strategy, business owners can get an upfront tax deduction from their premium payments, which means lower taxable income this year. You also get a lower future tax rate because you pay capital gains tax on any distributions, not regular income tax. Not to mention the fact that the insurance company may not have to pay tax on its income if it stays below that $2.85 million threshold.
If you are a business owner and are wondering if the captive insurance strategy could be the right fit for you, reach out to a Certified Tax Planner today.
