All right, for a couple of minutes today, we're going to jump into a really cool tax strategy surrounding insurance. It's not life insurance, not whole life insurance. It's not annuities that a lot of people might be trying to sell you, but it's related to captive insurance.
So if you hear of captive insurance, just immediately think of self-insurance. So captive insurance is where you create your own insurance company and you're paying premiums, which is, it's a company separate from your own business, and you're paying premiums over to that business. But one of the coolest things about this is that you can, and this is typically an add-on insurance that you'll get after your regular insurances.
So if there's types of things that you're not covered, say it's like cyber insurance or fraud or loss of revenue or defamation or just any different types of things that you want to insure against related to your business, you need to have a business. And if you don't get the coverage you want or the amount of coverage you need, or it's just insurance companies don't even offer it to you at all, you can create a captive insurance company. So here's the gist of it and why it's so powerful as a tax strategy.
So when you pay money, and you can do up to like $2.8 million of premiums a year, and it's, remember, it's not you creating the amount of premiums. You are partnering typically with a company that helps you set up the captive insurance company and they calculate the premiums and they adjust for the risk, et cetera, but you pay them a small fee and here's how it actually works. Like here's the mechanics of it.
So let's say you do the math on it. You're working with this company, you set up, it's a separate corporation, which is actually a, an insurance company because you need, you need that to not have to pay tax on the premiums. This is how it works.
So money that come, money will come from your business, like your operating company, whether it's an S corporation or whatever type of business it is. Money comes out of your company and it's paid out in premiums to this captive insurance company, which you control, but it's a separate, completely separate entity. When the money comes out of your regular business, you get a deduction for that.
So let's just say it's a lot, say it's $100,000 and I'm sure you could, you could scale it back to whatever makes sense. But say $100,000 comes out of your operating company, goes over to your captive insurance company, paying your insurance premiums, you will save, if you're in the highest tax bracket, you'll save almost $40,000, like a 37% tax bracket. And if you got state tax on top of that as well, it could be more, you'll save $40,000 in taxes because it's a tax deduction for you.
Then there's $100,000 over in this captive insurance company, this corporation it's a set up and structured exactly how the tax law intended, where it can be completely tax free. Those premiums are tax free to that captive insurance company up to $2.8 million a year. And the money just sits there.
The money you can't, you can't pull the money back immediately. The money just sits there until a future date. So remember step one, you transfer the money, you've saved $40,000 of taxes, but now you have $100,000 of cash just sitting over in this other captive insurance company.
Eventually say it's years down the road and you go, okay, I don't need that insurance policy anymore. Let's close the captive insurance company. When you close that captive insurance company and you, you pull money out of this corp, this captive insurance company, this corporation, when you pull money out of that, at that point, that's when it becomes taxable.
But here's, here's the beauty of it. Here's the tax arbitrage where you actually save money on it. It's you saved money at 37% in this highest tax bracket when it went in, right? So you save say almost $40,000 when it comes back out to you, you're taxed at the dividend rate, which is 15 to 20, 15 or 20% depending on your income level.
So worst case scenario, you're paying 20% tax on that income as it comes out. So there, there's some tax arbitrage there. You save 40 when it goes in, but you're paying 20 when it comes back out.
But in the meantime, you've got insurance coverage. You've got to say a nest egg of insurance in case something does pop up and you need to pay, pay out for some sort of risk that you were trying to insure against. But there's the gist of it.
There's captive insurance companies. We do have some recommended partners that we've worked with in the past that our clients have worked with. And we don't at Beamonton company or in the Franklin Alliance, we don't set up the captive insurance companies, but we have some partners that do, and we think they do a great job.
But I don't know, a couple thousand dollars, two to $5,000 is kind of my rough estimate of how much it might cost to set up one of these captive insurance companies and a couple thousand dollars of annual maintenance fees. So it's got to make sense. And if you can do it every year, of course it'll compound and the tax savings could get increased there.
But that's it for today. That's captive insurance company, company, the strategy, that's kind of just a high level review of, of how it might work and how it does work, but how it might work for you. If it's part of strategy, you remember if you're in these highest tax brackets and you have a business, that's usually you kind of need to check those two boxes, those higher tax brackets, and you have an operating business.
If you, or even if you've got taxable income and you've got rental businesses or other types of investments that could help, that could potentially be scenario where it might make sense for you, but high income, and you got a business already, typically not just a W-2 employee, but captive insurance. There it is. See you later.
